The solution is not a simple substitution. There are inherent differences between SOFR and LIBOR that will need to be adjusted for in the transition. For one thing, most contracts that reference LIBOR key off of three-month or six-month LIBOR. Mortgages often use one-year LIBOR. But SOFR is an overnight rate—there’s no such thing as three-month or six-month SOFR. One solution to this difference is to use the daily SOFR for each day during the term, either averaged or compounded each day until the end of the period. ISDA has indicated that derivatives will fall back to this kind of average, and the SOFR floating rate notes issued recently use a similar approach. To facilitate this method, the New York Fed is preparing to produce a backward-looking compounded average alongside the daily SOFR. Some market participants may need to use a forward-looking “term SOFR” created by constructing a yield curve off of trading in forward-looking SOFR derivatives, particularly for legacy contracts that already reference a term LIBOR rate. Creating a new rate like that is part of the ARRC’s transition plan, although it’s more concept than reality at this point. But under all of the cash product consultations put out to date, the first preferred fallback is to that kind of term rate, if such a rate were to be created that was up to IOSCO standards and endorsed by the ARRC.
What we don’t know is what the shape or timescale of the recovery will be. It’s going to be some time before we have a clearer view of the effects on other industries, including autos, higher education, manufacturing, and professional services. Our Response Despite this extraordinary uncertainty, at the Federal Reserve we worked quickly to put measures in place to support the economy and set the foundation for a strong recovery. During the first half of March, the Federal Open Market Committee (FOMC) brought the target range for the federal funds rate to near zero.1 The FOMC has indicated that it expects to keep interest rates at this level until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.2 Bringing interest rates down to near zero serves two purposes. First, low interest rates make it easier for households and businesses to meet their borrowing needs. Second, they foster broader financial conditions that will help promote the rebound in spending and investment needed to return the economy to full strength. The New York Fed The New York Fed has important and unique responsibilities in supporting liquid and wellfunctioning financial markets. Working alongside our colleagues in the Federal Reserve and other agencies, we are taking rapid and significant actions to supply liquidity and to stabilize critical parts of our financial system.