It has been said a thousand times, but the days of Libor are numbered. Since the Bank of England set a retention period for the December 21, 2021 interest rate, efforts to replace it have gathered pace.
Across the world, the financial industry has seen the emergence of alternative rates, each designed independently and with its own advantages and disadvantages. To name a few; the United Kingdom has Sonia, EU € STR, Japan has Tonar
and in the United States, the New York Fed has worked hard to develop the secure overnight finance rate (SOFR).
However, over the last year or so, what seemed like a simple and comparable process has become more complex. In the United States at least, the discussion of how best to replace the Libor USD no longer focuses solely on SOFR, but has turned into a sort of patchwork of various rates that each work in different ways and provide functions. different to different market sectors. .
See also:Introduction to SOFR
For more introductions on a number of topics, please visit www.iflr.com/primers
One of these alternative rates is the American Interbank Offered Rate – or Ameribor – which is published by the American Financial Exchange (AFX), a self-regulated electronic exchange on the CBOE platform launched in 2015.
What is Ameribor and what does it do?
According to The Ameribor site, this is a new benchmark interest rate that reflects the real costs of unsecured borrowing by banks and financial institutions.
“Although useful in their respective markets, neither Libor nor SOFR meets the requirements of thousands of banks through America that does not borrow from Libor or SOFR to finance their balance sheets. These banks need a benchmark that reflects their actual borrowing costs. This
the reference is Ameribor. ”
While SOFR is based on secured – or collateralized – loans, Ameribor contains a credit spread component based on unsecured loans, which means it is more representative of the cost of funding some banks.
Why should there be multiple tariffs?
The London Interbank Offered Rate has served several purposes. As a multifaceted rate, it has been applied to financial instruments and contracts all over the world. Now that the time has come to replace it, there is a strong and cohesive school of thought that argues for multiple rates to replace one: why choose one when you can have several that are tailor-made.
According to Richard Sandor, founder of Ameribor and chief executive officer of the American Financial Exchange, having multiple references will improve market efficiency, innovation and lower transaction costs.
“Multiple rates will also lead to greater innovation. AFX connects borrowers and lenders across the United States, creating, for the first time, a national market for unsecured loans. AFX now has its data on the blockchain, a first of its kind initiative aimed at offering greater transparency to market players, regulators and academics ”, he told IFLR.
Christopher Giancarlo, former chairman of the Commodity Futures Trading Commission and member of the AFX board of governors, agrees. “I think, as many do, that there is no reason why the Libor – which was a singular rate – should be replaced by a singular rate,” he says. “If you look at almost all of the areas where benchmarks are prevalent, there is a range of benchmarks across all asset classes.”
How it works?
Using the CBOE AFX platform, Ameribor is actually an index of the credit-weighted average unsecured loans of its members. AFX connects borrowers and lenders across the United States, creating a national market for unsecured loans. AFX stores its data on the blockchain with the aim of offering greater transparency to market players, regulators and academics.
“Unlike other markets which only provide information on the time, quantity and price of transactions, AFX now has records with additional data fields linked to each transaction,” says Sandor.
This additional data includes: the entire order book at the time of each transaction; the geographic area of the counterparties to each transaction; and detailed information about the counterparty, such as credit rating, type of institution and detailed financial metrics for each counterparty.
Ameribor is quoted on a real account / 360 days, following the working day convention and rounded to the fifth decimal place.
Who is using it ?
Over 1,000 US banks and financial institutions are currently members of AFX and use Ameribor, primarily in the small and medium business category. John Deere and American Electronic Power both recently became members, and this month Citizens Financial Group, one of the 20 largest banks in the United States with $ 177 billion in assets, joined the exchange.
What does SOFR not do?
As stated earlier, compared to SOFR, the big difference between the two rates is that the Ameribor contains a credit spread component based on unsecured loans. This means that the rate is more suitable for small and medium-sized banks which are less likely to use secured loans.
See also in Practice Insight: Mid-sized banks say not to impose SOFR on us
Outside of the largest institutions, few U.S. banks have sufficient cash flow to borrow money to cover day-to-day funding. “We don’t have huge investment portfolios like brokers do. Most banks, including many large banks, do not have large pools of investment securities to borrow from, ”said Tom Broughton, President and CEO of ServisFirst Bank. , a Birmingham, Alabama-based bank with approximately $ 8 billion in assets.
“It’s very simple: SOFR does not reflect the cost of bank funds, whereas Ameribor does.
Scott Shay, chairman of New York-based Signature Bank, which held just under $ 50 billion in assets in 2019, stresses the importance of letting the market decide the clues, adding that there shouldn’t be fixed index – or imposed by a large bank – for any business of any size.
“Any Iosco-compliant index should be protected when the Libor vanishes. The reason banks like ours, like Ameribor, is because anyone can participate. It is publicly traded on a publicly accessible financial market and is tied to unsecured loan costs, ”he said. “We want to use it as a secured placeholder for unsecured loans.”
Using an index based on secure funding makes very little sense for medium sized secure banks. “If the big banks want to use it among themselves, we have no objection, but we don’t know why it has anything to do with Main Street,” Broughton adds.
Has it been ratified at the regulatory level?
Although AFX has been publishing Ameribor since 2015, it has only recently gained prominence. In late May, Federal Reserve Chairman Jerome Powell made a statement to Senator Tom Cotton confirming that market participants are able to choose the rate that best suits their needs.
This came in direct response to concerns that SOFR is not sensitive to credit, unlike Libor. “We have made it clear that the ARRC recommendations and the use of SOFR are voluntary and that market participants should seek to move away from Libor in the most appropriate manner given their specific circumstances,” wrote Powell.
See also in Practice Insight: Interview with ARRC President Tom Wipf
Following this, on June 25, AFX announced a milestone of record volume, reaching $ 1,000 billion in transactions since its inception.
Ameribor also complies with Iosco’s 19 Principles for Financial Benchmarks, which are reviewed and audited by an independent third party.
Is it prospective?
Under Libor, banks can grant loans based on the average interest rate over seven different maturities; one night, one week and one, two, three, six and 12 months.
One of the most pressing issues with SOFR right now is that it does not have a forward rate comparable to Libor.
Ameribor also does not have a term rate similar to Libor. Both SOFR and Ameribor have listed futures contracts that can be used to provide inter-commodity spreads to the trading community on a seven-day and three-month basis.
This will allow banks to hedge the interest rate exposure of the Federal Reserve System’s bi-weekly reserve requirements using seven-day futures contracts, and allow users greater exposure to future volatility in bank rates. interest.
See also in Practice Insight: UK loan market braces for world without term rates
© 2021 Euromoney Institutional Investor PLC. For assistance, please see our Faq.