ARRC’s Wipf ‘puzzled’ by appeal of Libor-like benchmarks

Credit-sensitive benchmarks face questions over inputs and compliance

The head of an industry group tasked with leading the transition away from US dollar Libor has urged market participants to be wary of adopting any replacement rate “that just feels like Libor”.

“Why that would be appealing after all we’ve been through, I have no idea,” said Tom Wipf, chair of the Federal Reserve-backed Alternative Reference Rates Committee. “I find that quite puzzling.”

Lenders and issuers are exploring a growing array of credit-sensitive alternatives to regulators’ preferred successor to US dollar Libor, the secured overnight financing rate, or SOFR. These include Ameribor, Bloomberg’s Short-Term Bank Yield Index and Ice Benchmark Administration’s yet-to-be released Bank Yield Index. 

BSBY and BYI are built using much of the same data as Libor – commercial paper, certificates of deposit and US dollar bank deposits, with bank bond transactions also added to the mix – and are closely correlated to the outgoing benchmark.  

Wipf noted that loan benchmarks that use commercial paper rates as an input can jump sharply when markets are stressed. “It’s clear why lenders would find this appealing, but it’s not very clear, speaking to non-financial borrowers, why they would feel this would be appealing to them. Because really, what’s the logic in having non-financial corporates’ costs go up because bank spreads or commercial paper is widening?”

Wipf was speaking at Risk.net’s Libor Live event on April 27.

Subadra Rajappa, head of US rates strategy at Societe Generale, said enthusiasm for credit-sensitive term rates appears to be waning after years of hype. “After having many discussions with many investor types on the need for a forward-looking credit-sensitive term rate, what has happened in practice is that people have, over the past several years, given up on the idea that they’re ever going to have one and they’ve invested a lot of time and effort into SOFR,” she said at the event. “There’s virtually nothing being traded in all of these alternative benchmarks.”

She described the investor reaction to a recent $1 billion floating rate note issuance from Bank of America benchmarked to BSBY as “tepid”.

Debate over credit-sensitive benchmarks has intensified since the UK’s Financial Conduct Authority signed Libor’s death warrant on March 5. The most commonly used US dollar Libor rates will continue to be published until June 2023, though regulators have called on firms to stop entering into new Libor products after the end of this year.

What’s the logic in having non-financial corporates’ costs go up because bank spreads or commercial paper is widening?

Tom Wipf, Alternative Reference Rates Committee

But SOFR has received a cool response from lenders. As a secured overnight rate based on US Treasury repo transactions, SOFR lacks the credit sensitivity and term structure intrinsic to Libor. Lenders see the former as crucial for risk management, while the latter gives borrowers better visibility on interest payments.   

Several US regional banks have already linked cash contracts to Ameribor, a measure of overnight lending among 200 regional banks conducted over the American Financial Exchange. Zions Bank will begin using a new 30-day term version of the rate, which combines AFX trades with wider bank funding data, for commercial lending later this year. ED&F Man and First Merchants Bank transacted the first interest rate swap indexed to Ameribor in December.

Other credit-sensitive benchmarks are preparing to enter the fray. IBA has been developing BYI since 2018 and currently publishes indicative one-, three-, and six-month versions of the index on its website. IHS Markit is also readying a credit-sensitive benchmark, though it does not yet publish any rates.

On March 31, online learning firm SOFR Academy announced it would calculate and publish the Across-the-Curve Credit Spread Index, or Axi, a credit-sensitive benchmark developed by a group of academics led by Stanford University’s Darrell Duffie.  

Before these benchmarks can be used in transactions, investors will need assurances that they are compliant with international standards. Bloomberg hired an accounting firm to independently confirm that BSBY meets the International Organization of Securities Commissions’ principles for financial benchmarks.

Rajappa questioned whether that would be enough to satisfy investors: “Another concern that some investors have highlighted is, yes, it’s Iosco compliant now, [but] what happens if things change and it’s not Iosco compliant seven years from now? And what if the regulatory bodies push back on these down the line and we’re left with the same situation we’re in with Libor?”

Jack Hattem, deputy chief investment officer of BlackRock’s Obsidian platform, said credit-sensitive rates will probably have a place in the post-Libor US rates market, despite the question marks hanging over them. “These products are not being created out of thin air just for the sake of creating other products,” he said. “They do fill a need in the market.”

He also played down concerns that a proliferation of alternative rates will split liquidity. “I think we’re still going to have the majority of liquidity be on the SOFR curve in the US,” he said. “And folks need to carefully evaluate the aspects of these other indexes and how they fit into portfolios.”