Regulators warn of potential ructions in final stretch of Libor transition

- The drop in the Secured Overnight Financing Rate, the preferred replacement for Libor, raises concerns about potential ructions in the final stretch of the transition.

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With a little more than two months until market participants are prohibited from entering into new agreements tied to the London interbank rate, SOFR slipped 2 basis points this week to 0.03%. This rate volatility will likely be a focus for bankers at the next gathering of the Alternative Reference Rates Committee, the Fed-backed body that is overseeing the transition away from Libor in the U.S. on Tuesday when it hosts a symposium.

Entering this crucial period for Libor transition where banks and loan officers will now determine which new benchmark mark best serves their and their customers needs, the last thing SOFR needed was another reason for institutions to not use it, BMO strategists Dan Krieter and Daniel Belton wrote in a note to clients.

Of course, contracts will use a SOFR average so the daily gyrations aren t the end all. Yet while the financial system assumed that SOFR would be the primary benchmark rate in the post-Libor world, this latest stumble may give some end-users pause as they determine their preferred Libor alternative. Regulators have been urging market participants not to wait for Dec. 31 and some have said progress needs to accelerate.

SOFR has already been criticized for its lack of a credit-sensitive component and forward-looking rates - though the ARRC formally endorsed CME Group's term structure in July - and spurred some investors to look at other options. While enthusiasm for non-SOFR alternatives has faded in recent months, there still remains significant interest for other potential replacements, from Ameribor and the Bloomberg Short Term Bank Yield Index and ICE s Bank Yield Index. The Bloomberg Short Term Bank Yield Index, known as BSBY, is administered by Bloomberg Index Services Limited, a subsidiary of Bloomberg LP, the parent of Bloomberg News. Some strategists expect the rate to return to 0.05% as early as next week when the GSE cash exits and the Treasury's two -, five- and seven-year auctions settle, which will add more collateral to the repo market.

Even if the decline in SOFR proves to be temporary, there s still questions about whether it is a suitable replacement, especially from those investing in floating-rate notes tied to the benchmark, according to Bank of America. Should SOFR remain low or even drop further, investors may demand more compensation for so-called floaters as the securities are repriced lower.

SOFR is a difficult and difficult to predict index, BofA strategists Mark Cabana and Katie Craig wrote in a note to clients. To understand variations in SOFR one must understand complex intricacies of the overnight UST GC repo market which are detailed even for veteran money market participants. How do Donald Trump, Elon Musk, and Gwyneth Paltrow short-circuit your ability to think rationally?

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