Markets and Economy
Goodbye LIBOR, hello SOFR
The transition from LIBOR has led to major changes in the pricing of global financial products. Here’s what businesses need to know.
As of Jan. 1, 2022, the four non-U.S. dollar LIBOR benchmark rates—the British pound (GBP), Japanese yen (JPY), Swiss franc (CHF) and euro (EUR)—along with the one-week and two-month USD LIBOR, are no longer published1. The end of these rates is part of the final cessation of LIBOR—and all remaining USD LIBOR rates will be discontinued after June 30, 2023.
Globally, 2021 was the beginning of the end for LIBOR. In October, U.S. state and federal financial regulators reiterated their expectations that supervised institutions with LIBOR exposure would progress toward an orderly transition away from the benchmark. To do so, the agencies strongly advised institutions to no longer use USD LIBOR as a reference rate on new contracts after Dec. 31, 2021, and to ensure existing contracts have robust fallback language that includes a clearly defined alternative reference rate.
LIBOR will reach its final retirement on June 30, 2023. It’s critical for businesses to understand how they may be affected as markets, regulators and companies acclimate to life after LIBOR and the various transition deadlines.
New rates like SOFR replace LIBOR
It’s imperative businesses learn about replacement benchmarks. Regulators around the globe have developed more robust and transaction-based risk-free rates (RFRs) that are compliant with IOSCO financial benchmark standards for almost $400 trillion of wholesale and consumer products.
What is SOFR?
The Secured Overnight Financing Rate (SOFR) is J.P. Morgan’s preferred alternative to USD LIBOR. The Federal Reserve created the Alternative Reference Rates Committee (ARRC) in 2014 to develop SOFR as an alternative RFR, which has been published on an overnight basis since 2018.
How does SOFR work?
SOFR is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities in the overnight Treasury repurchase agreement market. Several variants are available, but the one that we believe looks and feels the most like LIBOR due to its term structure is Term SOFR, which is published in one-, three-, six- and 12-month2 forward-looking rates. Term SOFR is J.P. Morgan’s preferred rate, but if you would like to discuss the other variations of SOFR, please contact your banker.
Credit-spread adjustments with SOFR
Credit-spread adjustments are another important thing to understand about SOFR. LIBOR and other RFRs like SOFR use different methodologies, meaning there may be differences between the published rates of benchmarks. As institutions transition, they may look to utilize credit spread adjustments to try to better align secured SOFR rates to unsecured LIBOR rates.
J.P. Morgan’s approach to the transition
J.P. Morgan has worked to ensure that our entire firm is prepared for the transition. We’ve undertaken major legal, operations, systems and communications work related to the transition to ensure a smooth path. Some of the items we’ve addressed include the assessment of fallback rates, document amendments, multicurrency facilities, syndicated loans, hedge accounting and coordination across RFRs, among other items.
What steps should your business take?
Given the scale of the shift from LIBOR to SOFR, it’s important that businesses take all necessary actions to prepare themselves and their finances. At a high level, we recommend that you:
- Be aware of key upcoming milestone dates
- Understand LIBOR-related provisions of your loan documents
- Learn about SOFR and consult with your own independent professional advisers
- Be sure that your internal systems and processes can accommodate new alternative rates
- Be responsive to lender outreach around needed remediation work
Being proactive can help your organization prepare for LIBOR cessation and aid in the necessary transition.
The firm will continue to provide updates through the June 30, 2023, LIBOR deadline, and we look forward to working with you closely during the process.
If you have questions, please contact your banker.
1. With the exception of the 1, 3 and 6 month JPY and GBP LIBOR rates, which will continue to be published for a limited period after December 31, 2021, using a “synthetic” methodology, which has been noted by the U.K. Financial Conduct Authority to no longer be representative of the underlying market.
2. Please note that 12-Month CME Term SOFR has not yet been endorsed by the ARRC for benchmark replacement and fallback language but may be used for pricing in new deals.