LIBOR Transition

The London Interbank Offered Rate (LIBOR) is currently the world’s most widely used benchmark for short-term interest rates. Leading banks periodically report how much it would cost them to borrow in U.S. dollars from another bank on an unsecured, short-term basis. This information is used to determine LIBOR. Each bank’s reported borrowing cost does not have to be based on actual borrowing transactions and may be estimated within defined parameters. An estimated $200 trillion in derivatives, variable-rate mortgages, auto loans, commercial loans, credit cards, and other financial products are tied to LIBOR.

Industry groups and regulators have proposed a number of alternative benchmarks to replace LIBOR. The Board of Governors of the Federal Reserve System and the Federal Reserve Bank of New York established the Alternative Reference Rates Committee (ARRC) to identify a preferred alternative. Large financial institutions, along with regulators and certain industry groups, participate in the ARRC. The ARRC has identified SOFR as its chosen successor to LIBOR and established a transition plan. The Federal Reserve Bank of New York began publishing the SOFR rate in April 2018.

Some constituencies have objected to a transition to SOFR and have proposed different replacement benchmarks for LIBOR, such as AMERIBOR, which is published by the American Financial Exchange (AFX). ARRC has since agreed that other alternative risk-free rates would be appropriate replacements to LIBOR.

City National Bank plans to transition its commercial and syndicated loans to SOFR and is considering other successor rates as well, including AMERIBOR.

The Secured Overnight Financing Rate (SOFR), administered by the New York Federal Reserve, is the recommended alternative to LIBOR for U.S. transactions.

Financial market leaders selected SOFR because it is one of several so-called “risk-free" rates (RFRs) available. RFRs are overnight interest rate benchmarks that regulators perceive to be more representative and reliable than LIBOR. This is because such benchmarks are based on liquid markets and can be calculated by reference to actual transactions, rather than estimates.

SOFR is a broad measure of the cost of borrowing cash overnight by U.S. Treasury securities in what is known as the repurchase agreement market. In terms of the transactions underpinning SOFR, it has the widest coverage of any Treasury repurchase rate available. In short, the transaction volumes underlying SOFR are far larger than those of LIBOR, roughly one trillion dollars and one billion dollars per day, respectively.

The New York Federal Reserve publishes SOFR online on a daily basis, and an internal oversight committee of that agency periodically reviews the rate production process.

The American Interbank Offered Rate, or “Ameribor”, is a transparent benchmark interest rate based on overnight unsecured loans on the American Financial Exchange (AFX). The AFX is a self-regulated electronic platform on the Chicago Board of Exchange (CBOE). Launched in 2015, the AFX currently has 163 members across the United States, and an additional 1,200 financial institutions who participate with their member banks.

Ameribor is determined by funding transactions between mid-size banks and non-banks, including broker-dealers, insurance companies, private equity firms, hedge funds, asset managers and finance companies. The volume-weighted average of these loans is calculated and published nightly by the CBOE.

According to the founder of the AFX and Ameribor, Richard Sandor, the emergence of Ameribor as an option for banks upon the expiration of LIBOR is “democratizing the way interest rate benchmarks are determined.” Ameribor is a domestic rate designed to complement other existing rates, such as SOFR, since it is not based on Repo transactions. Most importantly, Ameribor is a more relevant rate for regional banks across the United States. As Sandor describes it, Ameribor “provides a separate and distinct benchmark that reflects the actual borrowing costs” of small and mid-size banks. While SOFR is based on collateralized repo transactions, Ameribor contains a credit spread component based on unsecured loans. In this way, Ameribor is more representative of the cost of funding for banks that cater to small businesses across the United States.

“LIBOR was applied to so many different kinds of financial instruments and contracts around the world,” said John Coscia, Director – Portfolio & Funding at City National Bank. “So, in deciding on a replacement benchmark, it makes sense to offer more than one rate option to serve the diverse needs of our clients. And as an added benefit, multiple rates will help make this market more efficient and less costly.”

AFX has been publishing Ameribor since 2015; however, it recently gained more prominence when the FCA called for a worldwide transition away from LIBOR by the end of 2021. In late May 2020, Federal Reserve Chairman Jerome Powell issued a statement confirming that market participants were able to choose the rate that most suits their needs.

The Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency (“OCC”), and the Federal Deposit Insurance Corporation (“FDIC”) agreed and on November 6, 2020, they issued a joint “Statement on Reference Rates for Loans” (the “Joint Statement”). In it, they noted that “banks should assess the appropriateness of alternative reference rates in light of their funding costs and their customers’ needs.”

“This statement really mirrored the growing consensus among banks and financial institutions that the availability of different but complementary interest rate benchmarks would be the more effective and efficient way to serve our clients once LIBOR expires,” Coscia added. “My colleagues and I at City National are pleased to be able to soon offer both SOFR and Ameribor to our clients.”

The implications of reforming an interest rate, particularly if it involves discontinuation, will differ depending on the City National Bank product or service that you use. For example, different products or services have different fallback rates and fallback language, and some may not have any at all. Fallback language is a provision that contemplates a change or cessation of an interest rate and provides for the introduction of a new interest rate or means of determining a new interest rate. This could lead to, for example, a change in the value, tax or accounting treatment of the product or service, or the product or service no longer meeting the purpose you originally intended it to serve. It may also be the case that discounting rates or systems that you operate, such as accounting systems, may not be compatible with any new interest rate introduced.