Start Preparing Now for the End of Libor-Linked Loans, Securities

Williams said the biggest challenge of Libor's demise isn't liquidity of the lack of a term rate — SOFR is an overnight rate unlike Libor, which had forward term rates of 12 months or less — but "the willingness on the part of the market to stop using Libor. "We need a mindset shift where firms realize that every new U.S. dollar Libor contract written digs a deeper hole that will be harder to climb out of." 

Williams suggested that companies issuing Libor-linked products include "robust fallback language" in contracts "so that if Libor ceases to exist, chaos does not ensue." 

That is one of several recommendations endorsed by the Alternative Reference Rates Committee (ARRC), which is leading the transition effort from Libor to SOFR. The committee, consisting of private-market participants and convened by the Federal Reserve Board and New York Fed in cooperation with the U.S. Treasury, Commodity Futures Trading Commission and Office of Financial Research, also recommends that consumer products linked to SOFR, such as adjustable-rate mortgages, use an average of SOFR rates over a period of time rather than individual overnight rates because averages are less volatile.

The committee is still working on contract language and structures for SOFR-indexed home equity loans, reverse mortgages, car loans and credit card rates.

"There's still a lot of work to do, " said Timothy Kitt, head of pricing and execution at Freddie Mac, who also spoke at SIFMA's Libor Transition Briefing.

In the meantime advisors whose clients invest in variable-rate securities linked to Libor, have outstanding loans linked to Libor or are considering new Libor-linked loans or investments can keep up with developments during the transition through the AARC website, where they can also comment on "consultations" that ask questions about proposed structures, SIFMA's SOFR primer and briefs and SEC publications.

SEC staff recently published a statement on the Libor transition encouraging market participants to "proactively manage their transition away from Libor."

Among the statement's many recommendations for advisors: 

• Consider the effects of Libor's discontinuation when recommending products to clients or monitoring them for clients 
• Whether to disclose risks of the transition to investors after considering the impact on  liquidity and value of their investments.

According to SIFMA, 27 institutions have issued more than $136 billion notional in floating-rate securities tied to SOFR as of June of this year, in June and outstanding SOFR-linked notional across all products has grown from less $100 billion in May 2018 to over $9 trillion as of April 2019.