Of particular concern are the roughly $4 trillion in LIBOR-linked loans whose contractual language enables lenders to renegotiate their terms if the base rate changes. Financial firms need to become familiar with the alternative new benchmarks and determine which best conform to their needs. For example, a rate like SOFR caters to bigger players, while AMERIBOR, an unsecured rate derived from transactions on the AFX, is better suited for other types of financial institutions that borrow unsecured or don’t have access to the repo markets.
Asset managers are assessing their own exposure to LIBOR. For exchange-traded fund (ETF) and mutual fund investors, it will be up to the funds’ managers to do their own due diligence on the underlying holdings.
The transition to new benchmarks, and the creation of new markets that comes with it, will require building institutional infrastructure. That means that market participants, and regulators who support this change, need to be joined by accountants, lawyers and academics who can help provide the skills and understanding required to help everyone understand the changes and new options.
We have every reason to believe that the U.S. financial sector, the most developed, flexible and innovative in the world, will maintain an orderly and smooth transition to new interest rate benchmarks. Industry groups are organizing to educate stakeholders. There are contracts currently being traded on organized exchanges, which will provide greater transparency and price discovery and speed up adoption. In the long run, these changes will result in better outcomes for borrowers and for investors.
Richard Sandor is the Aaron Director Lecturer in Law and Economics at the University of Chicago Law School. He is also chair and CEO of the American Financial Exchange, an electronic exchange for direct interbank/financial institution lending and borrowing.