As of August, the proportion of derivatives using the US alternative reference rate SOFR is only 12.5%
[Asia Economy Reporter Park Byung-hee] Ford Motor Company in the United States announced earlier this month that it will apply the SOFR rate instead of LIBOR for the refinancing of its syndicated loan. This decision comes as LIBOR will no longer be applicable after the end of this year, prompting the use of the alternative rate, SOFR.
SOFR (Secured Overnight Financing Rate) is an interest rate published by the U.S. Federal Reserve (Fed) since April 2018 as an alternative to LIBOR. SOFR is the one-day repo rate secured by U.S. Treasury securities.
LIBOR is the interest rate applied by major global banks in the London financial market for short-term loans and derivative transactions, and it has served as the benchmark rate for global financial products for decades. However, after the global financial crisis, manipulation allegations surfaced, which were confirmed to be true in 2012. Next year marks the 10th anniversary of the confirmation of the LIBOR manipulation scandal, and major global financial institutions plan to allow the use of LIBOR only until the end of this year.
Accordingly, countries have introduced alternative rates to replace LIBOR, such as SOFR in the U.S. and SONIA (Sterling Overnight Index Average) in the U.K. The Fed has ordered existing LIBOR-linked contracts to be converted to alternative rate-linked contracts by the end of this year. Ford is joining this trend by changing its applied interest rate.
There were expectations that the deadline for LIBOR usage might be extended due to COVID-19, but the Financial Stability Board (FSB), an international financial regulatory body, firmly stated in June that there would be no extension. The FSB is an international financial institution established under the leadership of the G20 after the 2008 global financial crisis.
However, concerns remain that the transition to alternative rates is still sluggish.
According to the International Swaps and Derivatives Association (ISDA), as of August, only 12.5% of derivatives were issued based on the SOFR rate. Nearly 90% of derivatives still apply the LIBOR rate.
The somewhat positive point is that the proportion of products using SOFR has significantly increased compared to 7.4% in July. As the year-end approaches, this proportion is expected to rise sharply. Ford’s decision to apply the SOFR rate for bond refinancing is expected to prompt many companies to follow suit in the future.
However, there are concerns that the last-minute rate transition could cause significant turmoil in the financial markets. According to Bank of America (BOA), in the spring of last year, right after the COVID-19 pandemic began, the spread between the 3-month LIBOR and SOFR rates widened to as much as 1.4 percentage points.
The Wall Street Journal recently reported a surge in collateralized loan obligations (CLOs), citing the abolition of LIBOR as one factor. According to S&P Global Market Intelligence, CLO sales in the U.S. exceeded $19.2 billion in August, marking the highest level in nearly 10 years. CLOs are securities that bundle multiple lower-rated, non-investment grade bonds into a single financial product for sale. As LIBOR is replaced by SOFR, if financial market turmoil occurs, trading of lower-rated bonds could become difficult, so CLOs are used to preemptively mitigate risk. However, the WSJ pointed out that some products lack sufficient explanation regarding the rate transition, which could cause confusion.
© The Asia Business Daily(www.asiae.co.kr). All rights reserved.
