- So, apparently Morgan Stanley thinks “soaring Libor is the story of the year…” I believe the story of the year is Secured Overnight Financing Rate (SOFR) which the Fed will start publishing April 3; LIBOR is going into the history books. I am not saying the widening of the Libor-OIS spread is related to this, however, I suspect so.
- The widening of the Libor-OIS curiously coincided with the Fed’s initial announcement on SOFR in June’18, then again in towards the end of 2017 when it said it plans to start publishing SOFR in Q1’2018. It blew up finally, when it became clear that that date will be April 3.
- Libor setting was always partially subjective even in the good old days pre-2008, especially longer-dated tenors; after 2008, with many banks withdrawing, it has become increasing less transaction-based.
- According to the Fed, SOFR will be entirely transaction-based and it will be purely spot (O/N). This is a big divergence with the Libor-based structure. Has the market started to transition already?
- For example, custodians need to move to new systems for calculating compound term coupons from spot because even though market makers will start to build systems to trade futures and forwards, that will take time as it also needs regulatory approval.
- New debt products will reference SOFR, but existing ones must also have some reference to SOFR, especially longer-dated ones when Libor really becomes extinct in 2021. All this takes time as well, and, I suspect, it is not going to be that straightforward given the large legacy of Libor products out there.