Teasury contracts for deposits, loans, and derivatives of all kinds are frequently linked to LIBOR, the London Interbank Offered Rate, which has been the standard interest rate benchmark ever since there has been a global money market.
In the wake of the so-called "LIBOR-rigging" scandal it was decided that LIBOR would cease to be the benchmark, and various successors have been proposed.
However, the successor for the US dollar in overnight money - pushed by the US authorities with the Federal Reserve prominent amongst them – recently showed itself to be anything but a stable and transparent benchmark.
This is the Secured Overnight Funding Rate or "SOFR", and is the rate for overnight loans, normally to broker-dealers, secured on the stock which the broker-dealer has in its inventory. The stock must be readily-marketable securities, liquid, and preferably of higher credit quality like US Treasury bonds.
SOFR surged from 2.43% on 16th September 2019 to 5.25%, an increase of 2.82%, for the 17th September, when LIBOR rates moved by 0.01-0.04%.
This is "off the wall" for a supposedly transparent, accessible and reliable benchmark for multiple global markets.
The reasons appear to have been domestic-technical, as the typical cash transaction underlying SOFR is a repurchase agreement, much used by US securities houses who have a long inventory of stock and can use that to secure the best borrowing rates. Indeed, such borrowers may be unable to obtain unsecured finance at all.
But the explanation will be all the more disturbing for treasurers if their business starts to be priced on the basis of SOFR when:
- They have limited or no business in the markets and financial instruments that drive the setting of SOFR
- SOFR becomes influenced opaquely by onshore drivers, which an offshore player will be unable to pick up and anticipate
- The rate itself becomes volatile
- The rate therefore cannot be regarded as an indicator of the return on a risk-free investment, even if the investment is arguably free of credit risk because of the high quality of the security
- The rate will be regarded as containing considerable market risk, a characteristic that should disbar it from being used as a global benchmark at all
Bob Lyddon is an author for accountingcpd. To see his courses, click here.
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