CFTC's first release in SOFR First Transition Initiative series on LIBOR and SOFR swaps

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In a press release (HERE) on June 8th, the Commodity Futures Trading Commission (the “CFTC”) published its first release in a series called the “SOFR First Transition Initiative” as a best practice. One goal for this sort of “best practice” is to impact the liquidity in LIBOR and SOFR swaps, thereby slowly (a) increasing the spread on LIBOR swaps and (b) tightening the spread on SOFR swaps. In other words, make LIBOR swaps more expensive and SOFR swaps less expensive. Even for non-dealers, this announcement is important as it is not only a major step in such non-dealers’ liquidity+swap provider moving away from LIBOR, but as LIBOR becomes more expensive for the dealers, the non-dealers will start to appreciate that it will be more cost effective and competitive for them to demand SOFR products since they can hedge this product and achieve a lower fixed rate on the SOFR swap (when compared to a similar LIBOR swap). Below, I give some thoughts on the impact this has on non-SOFR swaps (e.g., BSBY and Ameribor) and larger summary of the attached PDF.

I would note that the attached does not impact exchange traded LIBOR swaps (see the last line on the last page of the PDF). As a result, dealer-to-dealer swaps executed on a Swap Execution Facility (a “SEF”) may continue, but the OTC dealer-to-dealer market will be impacted. This is only the first step in the “SOFR First Transition Initiative”…so expect more and more of these “best practices” to roll out as a way to accelerate the transition away from LIBOR swaps well before January 1, 2022.

  1. What is the “Best Practice”? Starting July 26, 2021, no more interdealer LIBOR linear swaps (i.e., outright swaps, swap spreads and curve trades), but instead these should all be SOFR linear swaps. USD LIBOR linear swap screens should be available for informational purposes, but not trading activity, until October 22, 2021. After October 22, 2021, interdealer broker screens for USD LIBOR linear swaps should be turned off altogether.
  2. What interdealer LIBOR Derivatives are not impacted? This announcement does not impact interdealer swaps that are LIBOR/SOFR basis swaps, LIBOR/LIBOR basis swaps, Forward Rate Agreements and Single Period Swaps. It also does not cover SEF or other exchange traded derivatives and cross-currency swaps. It only covers OTC LIBOR linear swaps described above (and in the attached).
  3. Does this impact Dealer to Non-Dealer swaps (e.g., end-users and regional banks)? As stated in the attached “Dealers may still execute USD LIBOR linear swaps with clients after July 26, 2021 and after October 22, 2021.” However, we now have a good indication of how the derivatives market here in the US is going to transition away from LIBOR.
  4. Non-SOFR Swaps? There is no mention of any credit sensitive rates (e.g., BSBY or Ameribor) in this best practice. Nothing too surprising about that since this relates to the interdealer market and the release is “SOFR First”. However, as any particular derivatives market transitions away from LIBOR, SOFR does have the greatest liquidity, but it will be demands and market developments from non-dealers (I expect) that will be the biggest driver for developing a swaps market in the credit sensitive rates. It would be great if someone published a “BSBY Second” document, but I think the joke may be lost on many…
  5. Best Practice vs Regulation. Although it is not a rule/regulation, I expect it to have an effect similar to the other “best practices” that have been issued by the ARRC or US bank regulators – i.e., the timing and requirements set-out in the attached are largely treated by dealers as a requirement akin to a regulation, unless a dealer has a strong business case to explain the need for an exception.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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