British pound coins and a U.S. one dollar bill are arranged for a photograph in London, U.K. (Photographer: Chris Ratcliffe/Bloomberg)

U.S. Libor Replacement, Two Weeks After Debut, Has Some Issues

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(Bloomberg) -- Two weeks after its debut, the presumptive heir to Libor in the U.S. is already running into some turbulence.

The Federal Reserve Bank of New York said Monday it had mistakenly included certain repo transactions in the settings for April 2 to April 12 for the new benchmark, which is known as the Secured Overnight Financing Rate, or SOFR. The bank investigated the readings after it received feedback from market participants about higher-than-expected volumes of repurchase-agreement deals underlying the SOFR rate.

While the New York Fed said it won’t revise the incorrect data, market participants are scrutinizing the new rate. Only Friday’s setting, published Monday, is untainted. Private-sector participants and regulators have tapped SOFR as the preferred replacement for the London interbank offered rate, the beleaguered benchmark that’s been marred by meager transaction volumes and manipulation.

“The road is going to be extremely bumpy,” said Thomas Simons, a money-market economist at Jefferies. The glitch exposes “the potential costs of transitioning quickly away from Libor.”

See this QuickTake on the presumptive Libor replacement.

Any hiccups in the transition are also jarring because it could upset the transition plan laid out by the Alternative Reference Rates Committee, which the Fed created in 2014 to shepherd the replacement for dollar Libor. The panel predicated its approach on the robust growth of market volume and depth in SOFR-based derivatives, as well as Libor being phased out after 2021. That’s when the U.K.-based Financial Conduct Authority has said it will stop compelling banks to enter Libor submissions.

While Libor has relied on input from bankers, SOFR is an overnight rate based specifically on overnight loans collateralized by U.S. Treasuries.

As part of the transition plan, CME Group Inc. plans to launch monthly and quarterly SOFR futures on May 7, pending regulatory review. Development of a deep derivatives market is critical because it would allow regulators to create longer-term SOFR-based reference rates beyond an overnight maturity. That’s a key goal in expanding usage among market participants.

“The key at this point is confidence,” Simons said. “We need to have total confidence in the rate.”

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