April 2019 - One of the key issues facing financial market participants and regulators today is the expected phase out of the London Interbank Offered Rate (LIBOR) as a benchmark interest rate by the end of 2021. LIBOR is the most widely used reference rate in the world. U.S. dollar LIBOR is referenced in more than $200 trillion in financial contracts, and while the majority of these contracts are derivatives, LIBOR is also used to set interest rates for everything from student loans to car loans to adjustable-rate mortgages. These LIBOR-based cash products are valued at approximately $8 trillion. With such a large dollar volume of contracts tied to LIBOR, it is safe to assume that every lender and financial market participant is likely to experience some change in their operations, financial management strategy, or product offering as a result of the LIBOR phase out.
In the United States, the Alternative Reference Rates Committee (ARRC), a working group convened by the Federal Reserve, was charged with identifying an alternative index to LIBOR and establishing a transition plan for the U.S. market. The ARRC has recommended the Secured Overnight Financing Rate (SOFR) as the replacement for LIBOR, and a paced, structured transition is underway.
The FHLBanks recognize that a smooth transition will be crucial to the stability of the financial markets, the operations of each regional FHLBank, and the operations of our shareholders. Therefore, we are active participants in industry working groups that are setting the standards and timelines for the transition. These include the ARRC and the International Swaps and Derivatives Association (ISDA) – the two primary bodies that are overseeing the transition for cash products and derivatives.
Additionally, it is critical that a robust market for SOFR debt be developed in order for the transition from LIBOR to SOFR to be successful. Investors need to be able to hold cash-based SOFR products on balance sheet in order to create a strong off-balance sheet market for SOFR-linked instruments such as derivatives. As the largest issuer of floating-rate debt, the FHLBanks are uniquely positioned to help develop and shape the market for SOFR-linked debt. Between November 2018 and February 2019, the FHLBank System issued 12 global SOFR-linked bonds in the capital markets, valued at more than $26 billion. Demand for this debt has been healthy, particularly among money market funds. Importantly, the FHLBank System maintains a constant presence in the market, so investors can have confidence that there will be a steady supply of SOFR-linked debt available.
In addition to coordinating with other FHLBanks and industry working groups, FHLBank Atlanta has established a multi-year plan to prepare our own operations for the LIBOR phase out. To date, we have updated our systems to be able to manage and model transactions using indices other than LIBOR. We have also revised our advance confirmations and credit and collateral policy to include fallback language addressing the discontinuation of LIBOR as a benchmark rate. This language is important to ensure continuity and stability for shareholders that use products that reference LIBOR for pricing, such as our Adjustable Rate Credit advance.
In December 2018, the Bank also launched its first adjustable-rate advance linked to SOFR. This advance is a natural offset to the SOFR-linked debt on our balance sheet. We also see this advance as important to the evolution of the wholesale funding market as the industry transitions from LIBOR to SOFR. While demand for SOFR-linked funding is just beginning to grow, our goal is to be at the forefront of the transition so when demand increases, we will be well-positioned to fulfill our shareholders’ funding needs.
Supporting Shareholders through the Transition
As preparations at the Bank continue, we will work to address all aspects of our operations that will be impacted when LIBOR is no longer available. Equally important, we view our preparations as critical to ensuring the cooperative is ready and able to continue meeting shareholders’ business needs at every stage of this transition.
We are committed to keeping shareholders informed of key developments and changes at the Bank that may impact how they conduct business with us. Over the past few months, we have published articles and provided regular updates on the transition, offering insights into the potential impacts of this market shift and how financial institutions can begin preparing today. Additionally, our 2019 Annual Member Conference will feature a panel of experts from the Bank who will discuss the implications of the LIBOR phase out and transition.
As our shareholders’ trusted advisors, we will remain engaged with industry working groups so that we fully understand how our business and our shareholders’ businesses must adapt as the transition progresses. We will leverage the expertise we gain to serve as a reliable resource to our shareholders and continue to provide funding solutions that support and reflect the evolution of the market.