Second Report

The Alternative Reference Rates Committee

March 2018
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

I. Background 

The Financial Stability Board (FSB) and Financial Stability Oversight Council (FSOC) have both

publicly recognized for some time that the secular decline in wholesale unsecured term money 

market funding by banks poses serious structural risks for unsecured benchmarks such as ICE 

LIBOR (LIBOR).1 Although significant progress has been made in strengthening the governance 

and processes underlying LIBOR, the scarcity of underlying transactions poses a continuing risk 

of a permanent cessation of its production.2 

Because U.S. dollar (USD) LIBOR is used in such a large volume and broad range of financial 

products and contracts, the risks surrounding it pose a potential threat to the safety and soundness 

of individual financial institutions and to financial stability. Without advanced preparation, a

sudden cessation of such a heavily used reference rate would cause considerable disruptions to 

and uncertainties around the large gross flows of USD LIBOR–related payments and receipts 

between many firms. It would also impair the normal functioning of a variety of markets, including 

business and consumer lending.

In its 2014 report, the FSB’s Market Participants Group estimated that, as of 2012, contracts 

referencing USD LIBOR totaled roughly $160 trillion in gross notional exposure. Updated 

estimates show that, as of the end of 2016, the total exposure to USD LIBOR was closer to $200 

trillion (Table 1), roughly equivalent to 10 times U.S. Gross Domestic Product. The notional size 

of the derivatives market accounts for 95 percent of the outstanding gross notional value of all 

financial products referencing USD LIBOR.3 However, USD LIBOR is also referenced in several 

trillion dollars of corporate loans, floating-rate mortgages, floating rate notes (FRNs), and 

securitized products. 

These LIBOR exposures dwarf the volumes underlying the wholesale unsecured term bank 

funding markets that LIBOR is meant to represent. The distribution of daily volumes of term 

unsecured funding transactions by the global systemically important banks (GSIBs) since money 

market fund reforms were put in place in October 2016 is shown in Figure 1. The median daily 

volume of three-month funding transactions (three-month LIBOR is the most heavily referenced 

tenor of USD LIBOR) is less than $1 billion, and there are many days with volumes of less than 

$500 million. The number of banks submitting to USD LIBOR is about half the number of 

 1 See Financial Stability Board, Reforming Major Interest Rate Benchmarks, July 2014, and Financial Stability 

Oversight Council, 2013 Annual Report, June 2013. 2 Ice Benchmark Administration Roadmap for ICE LIBOR, March 2016, relays the many steps that have been 

taken to strengthen LIBOR. 3 Although net exposures in derivatives contracts would be much smaller, gross exposures are still critical from 

a financial stability perspective. Netting opportunities would be uncertain in the event that LIBOR ceased 

publication because existing derivatives contracts do not in general have robust fallback arrangements for such 

an event. Untangling the numerous cross-institution financial obligations that would result from such an event 

would be operationally complicated and possibly contentious. In the interim, individual banks would not have 

certainty about the value of their positions as it would be unclear what rate should be paid or what rate would be 

received on any contract. 
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

GSIBs, and so the actual volumes underlying USD LIBOR are likely to be about half of those 

shown here. 

Volume

(Trillions 

USD)

End

2021

End

2025

After 

2030

After 

2040

Interest rate swaps 81 66% 88% 7% 5%

Forward rate agreements 34 100% 100% 0% 0%

Interest rate options 12 65% 68% 5% 5%

Cross currency swaps 18 88% 93% 2% 0%

Interest rate options 34 99% 100% 0% 0%

Interest rate futures 11 99% 100% 0% 0%

Syndicated loans 1.5 83% 100% 0% 0%

Nonsyndicated business loans 0.8 86% 97% 1% 0%

Nonsyndicated CRE/Commercial mortgages 1.1 83% 94% 4% 2%

Retail mortgages3 1.2 57% 82% 7% 1%

Other Consumer loans 0.1 --- --- --- ---

Floating/Variable Rate Notes 1.8 84% 93% 6% 3%

Mortgage -backed Securites (incl. CMOs) 1.0 57% 81% 7% 1%

Collateralized loan obligations 0.4 26% 72% 5% 0%

Asset-backed securities 0.2 55% 78% 10% 2%

Collateralized debt obligations 0.2 48% 73% 10% 2%

199 82% 92% 4% 2%

Table 1: Estimated USD LIBOR Market Footprint by Asset Class1

Exchange Traded 

Derivatives

Over-the-Counter 

Derivatives

Share Maturing By:

1

 Source: Federal Reserve staff calcuations, BIS, Bloomberg, CME, DTCC, Federal Reserve Financial Accounts of the Unites States, G.19, Shared 

National Credit, and Y-14 data, and JPMorgan Chase . Data are gross notional exposures as of year-end 2016. 2

 The figures for syndicated and 

corporate business loans do not include undrawn lines. Nonsyndicated business loans exlucde CRE/commercial mortgage loans.3

 Estimated 

maturities based on historical pre-payment rates

Consumer Loans

Bonds

Securitizations

Total USD LIBOR Exposure:

Business Loans2
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

Figure 1: Distribution of Daily Unsecured Funding Volumes of the G-SIB 

Firms Post Money-Market Fund Reform 

Source: FR2420 Report of Selected Money Market Rates and DTCC. Federal Reserve staff calculations based on daily 

volumes aggregated across fed funds, Eurodollar, certificates of deposit, and unsecured commercial paper 

transactions of the 30 global systemically important banks with tenors between 25 and 35 calendar days (for one 

month), 80 and 100 calendar days (three month), or 150 and 210 calendar days (six month) over the period October 

15, 2016 to June 30, 2017. 

0%

2%

4%

6%

8%

10%

12%

$100

million

$500

million

$1.0

billion

$1.5

billion

$2.0

billion

$2.5

billion

$3.0

billion

$3.5

billion

$4.0

billion

$4.5

billion

One-Month Funding Volumes

Median

Percent of days with

observed volume

0%

2%

4%

6%

8%

10%

12%

14%

$100

million

$500

million

$1.0

billion

$1.5

billion

$2.0

billion

$2.5

billion

$3.0

billion

$3.5

billion

$4.0

billion

$4.5

billion

Three-Month Funding Volumes

Median

Percent of days with

observed volume

0%

3%

6%

9%

12%

15%

18%

$100

million

$500

million

$1.0

billion

$1.5

billion

$2.0

billion

$2.5

billion

$3.0

billion

$3.5

billion

$4.0

billion

$4.5

billion

Six-Month Funding Volumes

Median

Percent of days with

observed volume
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

In response to recommendations and objectives set forth by the FSOC and FSB to address these 

risks, the Federal Reserve convened the Alternative Reference Rates Committee (ARRC) on 

November 17, 2014, with the support of the U.S. Department of the Treasury, the U.S. 

Commodity Futures Trading Commission (CFTC), and the Office of Financial Research (OFR). 

The ARRC was convened to identify a set of alternative USD reference rates that are more firmly 

based on transactions from a robust underlying market than USD LIBOR and that comply with 

standards such as the International Organization of Securities Commissions’ (IOSCO) Principles for 

Financial Benchmarks and to identify an adoption plan to facilitate the voluntary acceptance and use 

of these alternative reference rates.4 Specifically, the ARRC was given four objectives:

• Identify best practices for alternative reference rates. The ARRC was asked to consider the 

range of existing and potential reference interest rates and identify a risk-free (or nearly 

risk-free) rate or rates that in the consensus view of the members would represent best 

practice for use in certain new derivatives and other contracts. Considerations were 

to include, but not be limited to, the liquidity of the underlying market, the likely 

robustness of the market over time, market functioning issues, usefulness to all market 

participants, ability to produce and maintain the alternative rates, feasibility and 

viability of developing a robust market of financial instruments that reference the 

alternative rates, accounting and tax issues that might facilitate or hinder adoption, 

and whether the identified alternative rates are consistent with the Principles for Financial 

Benchmarks outlined by IOSCO.

• Identify best practices for contract robustness. The ARRC was asked to consider the best 

practices related to robust contract design in order to ensure that contracts are resilient 

to the possible cessation or material alteration of an existing or new benchmark.

• Develop an adoption plan. The ARRC was asked to identify the factors that would either 

facilitate or impede the adoption of the alternative rates identified or the adoption of 

best practices related to robust contract design, and to outline the necessary steps that 

the official sector and market participants could take to make the adoption more 

successful. Considerations were to include, but not be limited to, the creation of the 

necessary liquidity in contracts referencing the alternative rates, accounting or tax 

issues such as the use of simplified hedge accounting, industry-wide protocols, 

complementary uses of the rates such as for discounting, and back-office or recordkeeping issues. 

• Create an implementation plan with metrics of success and a timeline. The ARRC was asked to 

identify observable metrics that reflect the successful adoption of the best practices 

and the alternative reference rates that are consistent with those best practices, and to 

identify how participating firms will work to achieve these best practices over time. 

These metrics could include, for example, quantitative measures for the dollar value 

or share of new derivatives or other contracts that are linked to such alternative 

 4 International Organization of Securities Commissions, Principles for Financial Benchmarks, July 2013. 
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

reference rates. The recommendations should include an expected timeline and clear 

measures of success for the implementation.

The ARRC’s focus was directed toward identifying alternatives to USD LIBOR and developing 

plans to encourage voluntary adoption of its recommended rate rather than a mandated transition 

away from USD LIBOR. At the same time that the FSB recommended seeking alternatives to 

benchmarks such as LIBOR, the FSB also recommended that those benchmarks be strengthened 

to the fullest extent possible, and FSB members have actively engaged with the administrators of 

these rates to accomplish this.5 And the FSB report, Reforming Major Interest Rate Benchmarks, 

explicitly recognized that market participants’ uses of interest rate benchmarks are diverse and that 

they should be allowed to choose amongst rates that meet the IOSCO Principles for Financial 

Benchmarks.6

Similar private-sector groups were convened in the other currency areas for which LIBOR is 

quoted.7 In the United Kingdom, the Bank of England convened the Working Group on Sterling 

Risk-Free Reference Rates to select an alternative reference rate for sterling markets. In Japan, 

initiatives by major market participants led to the establishment of the Study Group on Risk-Free 

Reference Rates in order to facilitate the identification of potential alternative risk-free rate designs 

and administrators. In Switzerland, the National Working Group was recognized as the key 

forum for interest rate reform proposals. And in the euro area, a similar Working Group on Euro 

Risk-Free Rates has now been formed. To the extent possible, the ARRC has sought to coordinate 

its plans with these other groups. 

The ARRC held its first meeting in December 2014 and has met regularly since then to work 

toward these objectives. At the time of its inception, the ARRC consisted of representatives from 

15 large global interest rate derivatives dealers.8 As its work progressed, the ARRC invited several 

central counterparties (CCPs) and other organizations to join as non-voting members. The Board 

of Governors of the Federal Reserve System, Federal Reserve Bank of New York (FRBNY), U.S. 

Department of the Treasury, CFTC, and OFR have served as ex officio members of the ARRC. 

Following the release of its Interim Report and Consultation in May 2016, the ARRC formed an 

Advisory Group of key end users across a variety of market sectors in order to ensure that its 

recommendations reflected a wide consensus of market participants.9 The ARRC also held two 

public roundtables, in June 2016 and November 2017, to inform market participants and seek their 

views. Minutes and agendas of the ARRC’s meetings are posted on its website. 

 5 As part of this process, the Federal Reserve has participated as an observer to ICE Benchmarks 

Administration’s LIBOR Oversight Committee since 2014.

6 At the same time, the report recognized that authorities have a responsibility for ensuring that the financial 

institutions they regulate do not use reference rates in ways that pose undue risk to the institutions themselves, 

to market integrity or to overall financial stability. 7 LIBOR fixings are set for five currencies: the euro, Japanese yen, pound sterling, Swiss franc, and U.S. dollar. 8 See Appendix 1.

9 See ARRC Announces the Formation of an Advisory Group.
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

The ARRC has completed the tasks and deliverables requested by the official sector in 

November 2014: 

• On June 22, 2017, the ARRC identified the secured overnight financing rate (SOFR), 

which the Federal Reserve Bank of New York will publish in cooperation with the 

Office of Financial Research, as the rate that, in its consensus view, represents best 

practice for use in certain new U.S. dollar derivatives and other financial contracts. 

The ARRC considered a variety of factors in selecting SOFR, including the depth of 

the underlying market and its likely robustness over time; the rate’s usefulness to 

market participants; and whether the rate’s construction, governance, and 

accountability would be consistent with the IOSCO Principles for Financial Benchmarks. 

The ARRC also considered the input of a wide range of market participants, including 

feedback from its Advisory Group, in making its recommendation. The official sector 

has supported the ARRC’s choice: in an editorial following the decision, Jerome 

Powell and Christopher Giancarlo noted that the choice of SOFR “resolves the central 

problem with LIBOR, because it will be based on actual market transactions currently reflecting 

roughly $800 billion in daily activity. That will make it far more robust than LIBOR.”10

• On October 31, 2017, the ARRC adopted a Paced Transition Plan with specific steps 

and timelines designed to encourage use of its recommended rate (see Table 3). 

• ARRC members have been actively engaged in work led by the International Swaps 

and Derivatives Association, Inc. (ISDA, itself a non-voting participant in the work 

of the ARRC) to consider best practices for contract robustness in derivatives 

contracts. ISDA has outlined a proposed process for making those contracts resilient 

to the possible permanent cessation of LIBOR or other prominent interbank offer 

rates and is now focused on the specific implementation details of that process. 

Taken together, these steps represent substantial progress and much work has gone in to realizing 

them. When the ARRC was first convened, neither SOFR nor the other leading alternative 

considered by the ARRC existed. 

However, while the ARRC has made substantial progress, the instabilities inherent in LIBOR have 

also progressed. The scarcity of underlying transactions has made it increasingly difficult and 

uncomfortable for panel banks to submit to LIBOR, and since 2016 two panel banks have stopped 

contributing submissions to USD LIBOR altogether. The U.K. Financial Conduct Authority 

(FCA, the regulator overseeing LIBOR) has publicly discussed the efforts that the official sector 

has had to exert in order to persuade banks to continue to submit to LIBOR in recent years.11 

Recognizing that applicable regulations do not allow it to compel submissions indefinitely, last 

 10 Jerome Powell and J. Christopher Giancarlo, How to Fix Libor Pains, Wall Street Journal, August 3, 

2017.

11 See The Future of LIBOR, FCA, July 27, 2017. The U.K. Financial Conduct Authority’s statement 

confirming the agreement of LIBOR panel banks to support LIBOR until end 2021 can be found at 

www.fca.org.uk/news/statements/fca-statement-libor-panels.
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

year the FCA sought voluntary agreements with banks submitting to LIBOR panels to continue 

their submissions through the end of 2021. While LIBOR may continue publication past this date, 

it cannot be guaranteed to do so. 

The announcements from the FCA sparked wider awareness of the risks that the FSOC and FSB 

warned of, and participants in many cash markets using USD LIBOR are now actively seeking to 

mitigate their risks both by seeking more robust contract language and considering transitions 

away from LIBOR. The ARRC’s work has thus proved to be timely, and more necessary than 

many had previously considered.

II. The Recommended Alternative

In June 2017, the ARRC announced a broad Treasury repo financing rate, SOFR, as its 

recommended alternative to USD LIBOR. The ARRC considered a comprehensive list of 

potential alternatives, including other term unsecured rates, overnight unsecured rates such as the 

effective fed funds rate (EFFR) and overnight bank funding rate (OBFR), secured repo rates, 

Treasury bill and bond rates, and overnight index swap (OIS) rates linked to EFFR.12 After 

extensive discussion, the ARRC preliminarily narrowed this list to two types of rates that it 

considered to be the strongest potential alternatives: an overnight unsecured rate (the OBFR) and 

some form of overnight Treasury repo rate. The ARRC discussed the merits of and sought 

feedback on both rates in its 2016 Interim Report and Consultation. The ARRC made its final 

choice of SOFR after incorporating feedback from the consultation and from the members of the 

Advisory Group. 

SOFR will be published on a daily basis by FRBNY beginning on April 3, 2018.13 SOFR is a fully

transactions-based rate incorporating tri-party repo data, the Fixed Income Clearing Corporation’s 

(FICC) GCF Repo data, and bilateral Treasury repo transactions cleared through FICC (the 

structure of the U.S. Treasury repo market is discussed in Box 1). It will have the widest coverage 

of any Treasury repo rate available. As shown in Figure 2, taken together, the transactions 

underlying SOFR regularly exceeded $700 billion in daily volumes last year and have been growing. 

Over the first half of 2017, the average daily volume of transactions underlying SOFR was $754 

billion, representing the largest rates market at any given tenor in the United States (Figure 3). 

The volumes underlying SOFR are far larger than the transactions in any other U.S. money market

and dwarf the volumes underlying LIBOR or other term unsecured funding rates. 

Because of its range of coverage, SOFR is a good representation of general funding conditions in 

the overnight Treasury repo market. As such, it will reflect an economic cost of lending and 

borrowing relevant to the wide array of market participants active in these markets, including not 

 12 The ARRC’s Interim Report and Consultation discusses the range of rates considered in more detail. The 

range of rates considered is similar to that discussed in the FSB’s Final Report of the Market Participants Group 

on Reforming Interest Rate Benchmarks, March 2014. 13 See Statement Regarding the Initial Publication of Treasury Repo Reference Rates.
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

only broker-dealers, but also money market funds, asset managers, insurance companies, securities 

lenders, and pension funds. FRBNY has released roughly three years of historical data for SOFR 

and the other repo rates that it will produce. Recognizing that a longer history will aid in modeling 

SOFR, FRBNY has also announced that it is considering ways to release additional historical 

data.14 Based on the historical data released thus far, SOFR can be seen to move closely with

other available repo rates (Figure 4). It has tended to lie in the middle of the range between other 

available repo rates: it is generally a few basis points higher than rates based only on tri-party 

transactions (such as the Bank of New York Mellon’s Treasury Tri-Party Repo Index or the triparty general collateral rate that will be produced by FRBNY) but is generally lower and less volatile 

than DTCC’s Treasury GCF Repo Index. 

Although the ARRC seriously considered OBFR as its other leading candidate, a Treasury repo 

rate like SOFR was seen as potentially more resilient both by the ARRC and by the ARRC’s 

Advisory Group of end users, a clear majority of whom preferred a repo rate. While both EFFR 

and OBFR are IOSCO compliant rates, most overnight transactions in fed funds and Eurodollar 

markets at this stage are arbitrage trades involving a fairly limited set of cash providers who are 

ineligible to earn the interest rate on excess reserves (IOER) rate paid on funds deposited at the 

Federal Reserve and instead lend money to financial institutions that can deposit and earn the 

IOER rate at the Federal Reserve. Money market fund reforms have also led to some decline in 

unsecured overnight transactions volumes since 2016. In contrast, Treasury repo markets were 

seen as more resilient and an active source of funding for a wide range of market participants. The 

alternative reference rate selected by the ARRC must be able to withstand the weight of potentially 

having hundreds of trillions of dollars of contracts referencing it and must remain durable over 

time, a standard clearly met by SOFR.

 14 See The Role of the New York Fed as Administrator and Producer of Reference Rates, Lorie Logan, January 

2018. 
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

Box 1: The Treasury Repo Market

The U.S. Treasury repo market is composed of several segments:

• The tri-party repo market is used to finance general collateral pools rather than specific 

securities, and trades in this portion of the market are primarily settled on the books of 

Bank of New York Mellon.* General collateral repo (GC repo) Treasury transactions are 

secured by a range of Treasury securities that are accepted as collateral by the majority of 

intermediaries in the repo market. Money market mutual funds and securities lenders are 

among the most prominent cash providers in this segment, while securities dealers are the 

primary borrowers of cash. Dealers may use this cash to fund their own portfolios or they 

may also lend it to other participants in the repo market. 

• While most tri-party repo transactions are not centrally cleared through a CCP, one segment 

of this market is. The General Collateral Finance (GCF) repo market is the segment of 

the tri-party repo market cleared through FICC. GCF trades are blind brokered (meaning 

that the counterparties to the trade do not know who they are trading with) among clearing 

members of FICC. 

• In the bilateral repo market, participants designate the specific securities to be used for 

collateral, but many trades are still primarily intended to lend and borrow cash on a secured 

basis (cash trades) rather than to obtain a particular security (specials). In this portion of 

the market, cash providers tend to be professional investors such as asset managers or 

securities dealers themselves, while cash borrowers include prime brokerage clients. As in 

the tri-party repo market, securities dealers may also borrow cash in this market, or may 

borrow it and then lend it to other market participants. 

• As with the tri-party repo market, there is a segment of the bilateral repo transactions that 

is centrally cleared through a CCP, the bilateral Treasury repo transactions cleared through 

FICC's Delivery-versus-Payment (DVP) service. Unlike the GCF market, DVP trades 

are not necessarily blind brokered. 

SOFR will be based on three of these segments – the tri-party market settled at the Bank of 

New York Mellon, the GCF market, and cleared DVP bilateral repo market. Data on the 

remaining segment, uncleared bilateral repo transactions, are not presently available, although 

such data could be considered for inclusion in SOFR if it became available at a later time.

* JPMorgan Chase also currently settles some tri-party transactions but has announced that it intends to 

cease providing these services. Broker-dealers using JPMorgan’s government settlement services are in the 

process of transferring those transactions to Bank of New York Mellon. 
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

Source: Federal Reserve Bank of New York (link to data).

Average volumes over 2017H1, with the exception of 3-month T-bills, which are preliminary estimates from available 

FINRA Trade Reporting and Compliance Engine (TRACE) data over August and September 2017. 3-month volumes are 

based on all transactions with remaining maturities between 80 and 100 calendar days or 41-80 business days. Source: 

Federal Reserve Bank of New York; Financial Industry Regulatory Authority; DTCC Solutions LLC, an affiliate of the 

Depository Trust & Clearing Corporation; and the Board of Governors of the Federal Reserve System.

0

100

200

300

400

500

600

700

800

900

Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17

Figure 2: Transactons Volumes Underlying SOFR 

Tri-Party (excluding GCF) GCF Cleared Bilateral

Billions USD

0

100

200

300

400

500

600

700

800

Secured

Overnight

Financing Rate

(SOFR)

Overnight

Bank Funding

Rate

Effective

Federal Funds

Rate

3-month Tbills3-month

LIBOR

3-month AA

nonfinancial

CP

3-month

A2/P2

nonfinancial

CP

Figure 3: Daily Volumes in U.S. Money Markets

Billions USD

$754 billion

$197 billion

$79 billion

Est. $13 billionEst. $500 million $343 million $132 million
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

Source: Federal Reserve Board, Federal Reserve Bank of New York (link to data), and DTCC Solutions, LLC.

The Choice of an Overnight Rate 

The ARRC’s Interim Report and Consultation described the potential alternatives identified by 

the ARRC and the criteria it used to evaluate them. As noted in Section I, many of the official 

sector’s concerns regarding LIBOR were driven by the secular decline in banks’ short-term 

wholesale unsecured borrowing – the markets that LIBOR is meant to represent. In convening 

the ARRC, the Federal Reserve asked the committee to consider potential alternative rates based 

on more active and robust markets. According to these criteria, the markets considered should be 

highly liquid, with a large set of daily transactions, and that one should reasonably expect them to 

remain in this condition under all but the most extreme circumstances.15 

With these considerations in mind, ARRC members began their deliberations by creating a list of 

criteria to judge potential rates against (Table 2). The ARRC criteria rely heavily on the IOSCO 

Principles, with the view that any chosen alternative should meet those principles. This is in line 

with the work of the Treasury Markets Practices Group, which has likewise recommended the use 

 15 Given its paramount role in setting U.S. monetary policy, the Federal Reserve also requested that the ARRC 

avoid choices that could be seen restricting its flexibility in changing the monetary policy framework in the 

event that changes to the framework were considered in the best interest of meeting the Federal Reserve’s 

congressionally-mandated policy goals.

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17

Secured Overnight Financing Rate

Tri-Party General Collateral Rate

DTCC GCF Treasury Repo Rate

IOER Rate

ON RRP Rate

Percent Figure 4: Comparing SOFR to Other Repo Rates
Page 12 of 40

SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

of financial benchmarks that are consistent with the IOSCO Principles into its Best Practice 

Guidance.16 The choice of SOFR provides market participants with an IOSCO compliant 

alternative to LIBOR available for their use. 

LIBOR is used as a forward-looking term rate in financial markets, and recognizing this, the ARRC 

also included the existence or potential for a term market to develop among the criteria that it 

judged would ease the transition to any potential alternative. Nonetheless, as the ARRC 

considered possible term rates as potential alternatives to USD LIBOR, none was judged to 

satisfactorily meet its criteria. With nearly $200 trillion in financial contracts referencing USD 

LIBOR, the need for a reference rate based on a deep and robust underlying market was 

paramount, and this essentially limited the set of credible alternatives to overnight rates, which 

were judged to be based on the only markets with a deep enough set of transactions to support a 

rate as heavily used as USD LIBOR. 

Table 2: ARRC Criteria for Potential Alternative Reference Rates

• Benchmark Quality 

The degree to which the benchmark design ensured the integrity and continuity of the 

rate. The underlying market was evaluated according to its:

o Liquidity

o Transaction volume

o Resilience through periods of illiquidity

o Resilience to changes in regulatory approach

o Potential that the benchmark may constrain or be adversely affected by 

changes in the monetary policy framework

• Methodological Quality 

The degree to which the benchmark construction could satisfy the IOSCO Principles 

for soundness and robustness. Rates were also evaluated according to:

o Standardized terms for data inclusion

o Transparency of data

o Availability of historical data

• Accountability 

Evidence of a process that ensures compliance with the IOSCO Principles 

• Governance 

Evidence of governance structures that promote the integrity of the benchmark 

• Ease of Implementation

Assessed ease of transitioning to the rate, including: 

o Anticipated demand for and relevance to hedging/trading

o Existence of or potential for a term market in the underlying rate

 16 TMPG Releases Updated Best Practice Guidance to Address the Use of Financial Benchmarks, February 2016.
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

Because this is an important point, it is worth discussing the types of term rates that the ARRC 

considered and why each was ultimately seen as unsuitable for the ARRC’s recommendation:

• The ARRC considered several types of term unsecured lending rates – financial 

commercial paper (CP), certificates of deposit, term Eurodollar or term federal funds 

transactions – but did not view them as leading candidates because they share the same 

key structural difficulties as LIBOR. As discussed in Section I, even in normal times, 

short-term wholesale unsecured transactions are now relatively sparse. Further, term 

wholesale unsecured borrowing is typically substantially less frequent during periods of 

stress, particularly at longer maturities. For example, the Federal Reserve was able to 

publish its three-month AA-rated financial commercial paper rate series for only 10 of the 

40 trading days over November and December 2008. 

• The ARRC also considered term Treasury rates. There are precedents for the use of 

Treasury rates as term benchmarks; for example, historically, some floating-rate mortgages 

were based on the U.S. Treasury’s Constant Maturity Treasury (CMT) rates, although 

almost all new floating-rate mortgages now reference LIBOR. And, as shown in 

Figure 3, the average daily volume of transactions in 3-month Treasury bills is larger than 

the volumes for 3-month unsecured funding, although still much smaller than volumes in 

overnight repo or unsecured markets. However, while Treasury bill or bond rates scored 

highly against several of the ARRC’s main criteria (liquidity, robustness, existence of a 

term market), there are several criteria that the ARRC felt were not met. Most importantly, 

Treasury rates are not well correlated with measures of either private-sector financial or 

nonfinancial corporate borrowing costs (Figure 5). Treasury rates can also move 

idiosyncratically based on fluctuations in technical supply and demand factors that are not 

reflective of the true risk-free rate relevant to the market. ARRC members felt that these 

considerations made Treasury rates less appealing to most market participants because 

these rates are less effective in hedging private-sector risks and funding costs. Therefore, 

the ARRC believed it would be difficult to implement a transition from LIBOR to a 

Treasury benchmark.

• The ARRC also considered the potential to use term OIS rates linked to EFFR (the fixed 

rates negotiated to receive the floating compound average EFFR over a specified period) 

This OIS market is highly liquid, in the sense that trades of good size may be executed

with little price impact, deriving in part from the market’s tight links with other interest 

rate swap (IRS) and the Fed Funds futures markets. However, on a daily basis, there are 

relatively few transactions in this market at any given maturity, making it impossible to 

calculate a robust, fully-transaction based OIS rate linked to EFFR under current market 

conditions.
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

Source: Bloomberg, Ice Benchmarks Administration, and Federal Reserve Board.

The private-sector groups in the other currency jurisdictions each independently reached the same 

conclusion that there were no viable robust term rate alternatives to LIBOR. Like the ARRC, 

each has chosen either an unsecured or secured overnight rate, depending on the characteristics 

of their national markets.17 For example, the Swiss National Working Group chose the Swiss 

Average Rate Overnight (SARON), an overnight repo rate, as its preferred alternative; this choice 

was simplified by the fact that the predominant Swiss unsecured rate, the TOIS rate, ceased 

publication at the end of last year as the panel of banks that had submitted to it had fallen to too 

low a level for the rate to be viable. In the United Kingdom, the Working Group on Sterling RiskFree Reference Rates selected the reformed Sterling Overnight Interbank Average (SONIA), the 

overnight unsecured rate, as it was deemed more robust and afforded a simpler transition than the 

repo rates the group considered. The Japanese group selected the unsecured overnight call rate

(although the government securities repo market is fairly large in Japan, there is no transactionbased overnight repo reference rate currently in production).18 

Although it is an overnight rate rather than a term rate like LIBOR, SOFR should be easily 

incorporated into IRS and other derivatives contracts. Market participants are already familiar 

with OIS and futures contracts referencing EFFR, and derivatives contracts that reference SOFR 

can be structured similarly. While overnight repo rates are more volatile than term LIBOR rates 

on a day-to-day basis (a fact that is not only true of the available repo rates – the overnight 

unsecured rates such as EFFR and OBFR are also more volatile than term LIBOR, especially on 

month ends), derivatives contracts referencing SOFR would use an average of daily SOFR rates 

 17 Further information on the work of each of the currency groups can be found in the FSB’s Progress Report 

on Reforming Major Interest Rate Benchmarks, October 2017. 18 The Working Group on Euro Risk-Free Rates is expected to make the selection of its recommended 

alternative euro reference rate by the end of 2018.

0

1

2

3

4

5

6

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

3-Month Constant Maturity Treasury Rate

3-Month Nonfinancial Commercial Paper Rate

3M LIBOR

3M EFFR OIS

Figure 5: Treasury Rates versus Private Borrowing Costs

Percent
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

over a fixed period of time as the floating rate paid under the terms of the contract, not a single 

day’s realization of SOFR. For example, the floating rate on these instruments might be a 3-month 

compound average of daily SOFR rates. Those averages are similar to the averages of EFFR paid 

in current OIS contracts. They are much less volatile than the daily realizations of SOFR and are 

typically only minimally impacted by any volatility on quarter ends. In fact, a 

3-month average of SOFR is less volatile than 3-month LIBOR (Figure 6). 

Publicly available Treasury repo rate series extend back more than 10 years and appear to be 

reasonable proxies for modelling how a rate like SOFR would have behaved historically.19 Based 

on such historical data, averages of overnight repo rates like SOFR and overnight unsecured rates 

like the EFFR have tended to move together fairly closely over longer periods of time (Figure 7). 

Neither overnight unsecured rates nor overnight secured rates have much credit risk, and hence 

they will both generally move closely with the Federal Reserve’s monetary policy target. Thus, the 

economic differences between current OIS contracts referencing EFFR and future OIS contracts 

that will reference SOFR should be relatively small. 

But while SOFR should be relatively easy to incorporate into derivatives, instruments in which

many market participants are already familiar with contracts that reference an overnight rate rather 

than a term rate, participants in many cash products may find use of an overnight rate unfamiliar, 

even if it is averaged over time. Some participants and products might be able to adapt to the use 

of an overnight rate, perhaps especially larger firms with more sophisticated financing 

infrastructures or in consumer products, which require a safe and robust rate but not necessarily 

a forward-looking rate. But other market participants might find this type of transition more 

difficult. To address this issue, the ARRC has explicitly included a goal of producing a forwardlooking term rate for use in cash products in its Paced Transition Plan, which is discussed in the 

next section. 

 19 Prior to 2015, there were smaller differences across the different segments of the U.S. Treasury repo market, 

so that these publicly available rates are likely to be close to what a rate like SOFR would have been. See the 

materials included in the Presentation to the August 1, 2017 ARRC meeting.
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Compound Average SOFR is a compound geometric average of daily rates over the subsequent quarter. Source: 

Federal Reserve Bank of New York (link to data) and Ice Benchmarks Administration.

Forward Compounded Repo and Fed Funds Effective Rates are compound geometric averages of daily rates over the 

subsequent quarter. Repo rate data: Aug 2014-2017 from the Federal Reserve Bank of New York (link to data), prior 

data from ICAP/NEX (source: Bloomberg series IREPUSOP Index); Effective Fed Funds Rate: Federal Reserve Bank of 

New York; LIBOR: ICE Benchmark Administration. 

0

0.2

0.4

0.6

0.8

1

1.2

1.4

Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17

Figure 6: Averages of SOFR are Less Volatile than LIBOR

3-Month LIBOR 3-Month Compound Average SOFR

Percent

0

1

2

3

4

5

6

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

3M LIBOR

Compound Overnight Treasuries Repo Rate

Compound Effective Fed Funds Rate

Percent

Figure 7: Compound Averages of Overnight Secured and 

Unsecured Rates are Similar
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

III. The Paced Transition Plan

Because of the prevalence of LIBOR in USD interest rate markets, planning for any transition 

poses a host of challenges. The first of those challenges will be creating a baseline level of liquidity 

for derivatives contracts referencing SOFR. End users cannot be expected to choose or transition 

cash products to a benchmark that does not have at least a threshold level of liquidity in derivatives 

markets. The ARRC’s Paced Transition Plan (outlined in Table 3) is intended to progressively 

build the liquidity required to support the issuance of and transition to contracts referencing 

SOFR, and to create conditions in which a robust term reference rate based on derivatives 

referencing SOFR could be constructed and itself used in some cash products. 

Table 3: The Paced Transition Plan

Step

Anticipated

Date of 

Completion

1. Infrastructure for futures and/or OIS trading in SOFR is put in place by ARRC 

members.

2018 H2

2. Trading begins in futures and/or bilateral, uncleared, OIS that reference SOFR. End 2018

3. Trading begins in cleared OIS that reference SOFR in the current (EFFR) PAI 

environment.

2019 Q1

4. CCPs begin accepting new or modified swap contracts (swaps paying floating 

legs benchmarked to EFFR, LIBOR, or SOFR) that pay SOFR as PAI and are 

discounted with a SOFR curve. In this stage, market participants are allowed a 

choice at the time of execution of each trade between clearing contracts that 

calculate PAI and discounting using either EFFR or SOFR, with both types of 

contracts cleared within the same clearing guarantee fund. CCPs would 

gradually lengthen the maturity of contracts accepted for clearing in the new 

SOFR PAI/discounting environment to ensure that liquidity was adequate to 

support the new discount curve. 

2020 Q1

5. CCPs no longer accept new swap contracts for clearing with EFFR as PAI and 

discounting except for the purpose of closing out or reducing outstanding risk 

in legacy contracts that use EFFR as PAI and discount rate. Existing contracts 

using EFFR as PAI and discount rate and new contracts using SOFR as PAI 

and discount rate continue to exist in the same pool. Existing contracts roll off 

over time as they mature or are closed out. Methods for accelerating this close 

out, and the potential to pre-announce the closure of the CCPs’ EFFR-based 

PAI and discount rate capability, may play a part. 

2021 Q2

6. Creation of a term reference rate based on SOFR derivatives End 2021
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Initial Steps: PAI and Discounting 

The initial steps of the Paced Transition Plan map a strategy for migrating price alignment interest 

(PAI) and discounting (both described in Box 2) to SOFR. This planned migration is designed to

create a robust source of demand for derivatives referencing SOFR, consistent with the FSB’s 

recommendations, while avoiding any disruptive changes in existing contracts. It accomplishes 

this by focusing on a gradual transition for new transactions rather than a “big bang” that would 

seek to change PAI on existing trades or alter their discounting. 

There were several reasons that made the Paced Transition Plan’s focus on PAI and discounting 

natural to consider. First, because SOFR is an overnight rate, the need to build an initial level of 

demand and liquidity in derivatives markets referencing it will necessarily involve transitioning 

some current private-sector uses of EFFR, the current overnight index used for PAI and 

discounting, to SOFR. And second, as SOFR becomes a widely used alternative to USD LIBOR, 

it will be natural for market participants to seek to align PAI and discounting with the new rate. 

Box 2: PAI and OIS Discounting

Price alignment amount or price alignment interest (PAI): PAI for a centrally cleared 

derivative is an amount calculated by applying an overnight interest rate to the variation 

margin (VM) for the derivative in order to align the economics of the cleared derivative 

with the economics of uncleared derivatives (for which interest is paid on cash VM 

postings). The position holder who has a cleared derivative contract with positive net 

present value (NPV) – i.e. “in the money” – pays PAI and, conversely, the position holder 

who has a cleared derivative contract with negative NPV – i.e., “out-of-the money” –

receives PAI. For USD denominated derivatives, the PAI amount is calculated by applying 

the EFFR, which is annualized on an actual/360 basis, to contract NPV. Since PAI is a 

cost-of-funding adjustment, the interest rate is chosen in conformity with the currency 

denomination of the derivative contract. For centrally cleared derivatives, each CCP’s 

rules dictate the legal and regulatory treatment of both variation margin and PAI.

OIS discounting: OIS discounting refers to the discounting of expected cash flows of a 

derivative using a nearly risk-free curve. Most dealers and CCPs now use interest rates 

based on EFFR OIS rates for discounting of derivatives. Under OIS discounting, the 

specific reference rates linked to a particular swap are used to generate expected future 

cash flows, but the NPV of these cash flows is calculated using an OIS discount curve. In 

the past, the conventional way for pricing IRS was to discount the cash flows of the swap 

by using the LIBOR curve, but since the 2008 financial crisis, there has been a shift toward 

using EFFR OIS discount factors as market participants recognized that LIBOR and 

EFFR OIS rates had diverged and that EFFR OIS discounting was more appropriate. 

With this switch, USD PAI and discounting were linked to the EFFR, and many market 

participants now see a tight link between PAI and discounting as crucial to the 

effectiveness of their hedging strategies and accounting requirements. 
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Under the Paced Transition Plan, CCPs would announce that, as of a specified future date, PAI 

and discounting on newly registered IRS contracts for clearing would be calculated on the basis of 

SOFR. These new trades would exist within the same clearing pool as existing IRS contracts with 

PAI and discounting calculated using EFFR. In this scenario, as legacy contracts using EFFR for 

PAI and discounting matured, or were closed out or liquidated, over time, the clearing pool would 

consist of only IRS that use SOFR for PAI and discounting. 

Successful implementation of this plan will require voluntary trading by ARRC member banks and 

other market participants in order to achieve a critical mass of liquidity in futures contracts and/or 

OTC derivative contracts that reference SOFR. This will first require financial intermediaries to 

build internal infrastructures to support trading SOFR futures and swaps (Step 1 of the Paced 

Transition Plan). Progress is already underway: for example, the CME Group (CME) has publicly 

announced that it will introduce trading in SOFR futures and options and is preparing the systems 

necessary to do so.20 ARRC members believe that many of these infrastructures can be 

substantially built by the end of the second quarter of 2018. With these infrastructures in place, it 

is anticipated that futures trading and trading in uncleared OIS referencing SOFR will begin by 

the end of 2018 (Step 2), with cleared OIS trading beginning – subject to regulatory approval – by 

the end of the first quarter of 2019 (Step 3). 

Over 2019, trading activity in futures and OIS markets should foster an accumulation of price 

histories that will help market participants develop an understanding of the term-structure 

dynamics of longer-dated exposures in SOFR. This would allow CCPs to provide their members 

with a choice of clearing some instruments into a PAI/discounting environment based on SOFR 

by the first quarter of 2020 (Step 4). CCPs would then gradually lengthen the maturity of contracts

allowed to clear into the new environment as liquidity in longer-term SOFR derivatives developed.

After liquidity and the availability of adequate historical data for risk modelling have sufficiently 

developed, market acceptance of the new rate would allow CCPs to require that all new trades 

clear in to the SOFR-based PAI/discounting environment (Step 5). Assuming that the necessary 

market conditions have been met, this step could be taken by the second quarter of 2021. 

Although the plan refers specifically to PAI and discounting used by the CCPs given that most 

new standardized IRS contracts are now cleared, it is expected that counterparties will also seek to 

adjust the interest on collateral specified in their credit support annexes (CSAs) for uncleared 

derivatives to the new rate. This may take a longer period of time because amendments to these 

agreements must be negotiated bilaterally (although CSAs referencing LIBOR as the interest rate 

paid on collateral could be covered by the work that ISDA is considering on fallback language 

discussed in Section IV).

Under the Paced Transition Plan, legacy contracts cleared in the current PAI and discounting 

environment based on EFFR would gradually roll off. Mechanisms for closing out legacy 

contracts will need to be devised in order to both meet likely market demand and ensure the safety 

 20 See www.cmegroup.com/media-room/pressreleases/2017/7/26/cme_group_to_developderivativesonbroadtreasuriesrepofinancingrat.html and

www.cmegroup.com/trading/interest-rates/secured-overnight-financing-rate-futures.html
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

and soundness of the CCPs in case of a member default involving a significant legacy book. Some 

ARRC members have expressed interest in exploring mechanisms to accelerate the closing of 

legacy contracts in the EFFR-based PAI/discounting environment, but this has not been 

incorporated into the Paced Transition Plan itself and the feasibility of such mechanisms would 

depend on individual capabilities and interests. 

The initial steps in the ARRC’s Paced Transition Plan are intended to develop futures and OIS 

trading in SOFR. If the resulting futures and/or OIS markets were active and robust enough, 

then a forward-looking term reference rate could be created based on those markets as a final step 

(Step 6). Other cash products could then directly reference these term rates rather than directly 

referring to SOFR if some participants in those markets find it useful to do so. 

Contracts for loans or other cash products could be written on either a backward-looking average 

of SOFR or on a “in arrears” arrangement in which the floating rate is based on realized average 

of the overnight rate over the period (as in OIS and futures contracts). However, the floating-rate 

payments in these contracts would be different than the floating-rate payments in contracts that 

currently reference LIBOR because they are either (a) not predetermined at the start of the period, 

or (b) not a forward-looking term rate (OIS payouts reflect the ex-post actual movement in rates, 

while LIBOR reflects the ex-ante expectation at the given time of its fixing). These differences 

may pose difficulties to some customers who have grown accustomed to or whose systems require 

a pre-determined, forward-looking floating rate payment structure. In order to accommodate 

these participants and to ensure the possibility of a smoother transition for many cash products, 

the ARRC considers it important that a forward-looking term rate based on SOFR be created.

 

Final Step: Creating a Term Reference Rate 

Once the initial steps in the Paced Transition Plan are successfully accomplished and liquid 

derivatives markets referencing SOFR have developed, the final step (Step 6) in the Paced 

Transition Plan, the creation of a forward-looking term rate based on SOFR derivatives markets, 

should be possible. For the framework underlying the term rate to work well and to have enough 

underlying transactions to construct a term rate, the bulk of derivatives transactions would need 

to be based on the underlying OIS and futures markets. As a result, broker-dealers offering clients 

contracts on a term reference rate for other non-derivatives products would still need to hedge the 

positions in the underlying OIS or futures market. Nonetheless, the forward-looking term rate 

could provide a useful “front end” allowing many users of cash products to transition away from 

LIBOR more easily. 

The ARRC has discussed several different potential methods for creating a forward-looking term 

rate:
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1. Futures-Based

A synthetic constant-maturity term rate could be imputed by bootstrapping between the prices 

of nearby SOFR futures contracts. The exact details would depend on the structure of SOFR 

futures and SOFR OIS contracts; Appendix 3 provides an example of a potential methodology 

based on EFFR futures.

Currently, near-term federal funds futures contracts offered by CME average around $100 

billion in daily trading volume (averaged across contracts). Eurodollar futures contracts have 

$100-$300 billion in daily trading volume. If futures contracts on SOFR were expected to 

inherit these volumes, then a robust reference rate could likely be constructed using this data. 

Since the data underlying this rate would be bona fide transactions from a regulated exchange 

with governance and data control measures already in place, it should be feasible for a private

administrator of such a rate to meet the IOSCO principles. 

2. OIS-Based

A constant maturity term rate could also be constructed directly from OIS transactions. Those 

transactions could potentially include both new swap or other related trades and pre-existing 

trades that are closed out or renegotiated at a market rate. Swap execution facilities (SEFs)

that provide trading platforms or CCPs that provide clearing for OIS transactions could 

potentially provide the underlying data. Banks could also potentially submit transactions data 

to an administrator, however strong governance and data control measures would need to be 

put in place internally at each bank submitting data, similar to the governance and control 

measures in place for LIBOR submitters, in order for the reference rate to be IOSCO 

compliant. 

Confidential internal data shared by some ARRC members indicates that it might be difficult 

to create a robust term rate using only OIS transactions with maturities near to any given fixed 

term under current market conditions (e.g., there did not appear to be enough 3-month OIS 

transactions to robustly impute a 3-month rate on a daily basis). However, if the market for 

SOFR OIS developed sufficiently then this may become feasible. It may also be feasible to 

create a robust term rate based on a curve fit across all OIS transactions at a range of moneymarket maturities, with constant maturity rates then imputed from the fitted curve. 

3. Actionable Market Quotes

A term reference rate could in principle also be created based on the order books of one or 

more trading platforms, as is done with the ICE Swap Rates (formerly ISDAfix).21 ARRC 

members have expressed some preference for the other alternatives proposed rather than this 

type of system. The IOSCO Principles do allow for reference rates based on actionable 

quotes, but only in liquid markets in which transactions are regularly executed. And in the 

 21 See www.theice.com/iba/ice-swap-rate
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

presence of high-speed trading, order books taken at fixed points in time are not necessarily 

representative of actual trade prices. Hitting a quote on a given platform can quickly lead to 

changes in order books across multiple platforms so that “theoretically” filling a trade based 

on a snapshot of one or more order books can generate a fairly different implied price than 

would be obtained by actually executing a trade. Care would also need to be taken to ensure 

that quotes were not submitted and then quickly withdrawn in an attempt to influence the 

reference rate without incurring much risk of being executed. However, notwithstanding 

those potential hurdles, a term rate based on central limit order books approach may still be 

feasible. One consideration that would help to make this approach more robust would be to 

sample order books over a longer period of time, for example the full trading day or many 

hours over the day. 

In considering any of these methodologies, a few caveats should be recognized:

• The term reference rate must be IOSCO compliant.

• Because the term reference rate would be based on SOFR derivatives, the SOFRderivatives market would need to be highly robust, with a significantly larger volume of 

transactions than any activity referencing the term rate. If the volume of transactions 

referencing the term benchmark exceeded or even rivaled trading in the underlying OIS 

or futures market, then there would not be enough activity in the underlying market to 

actually support the term benchmark as a reference rate. It would also create many of the 

incentive problems associated with basing a substantial amount of transactions on a 

reference rate based on less robust underlying activity. 

• The actual swap rate that brokers would be able to obtain in the market on a given day at 

a given point in time would in most cases not equal the fixing for the term reference rate. 

This would create some basis between the rates paid on contracts referencing the term 

rate and the actual rates that dealers obtained in hedging those contracts in the underlying 

SOFR derivatives market. (This basis risk could be eliminated if the term reference rate 

was calculated based on a batch auction, in which all orders were submitted and the 

clearing price was taken as the benchmark fixing. This idea has not been taken up in other 

markets, but could be considered here as another potential method for calculating the 

term rate.)

• Finally, it is important to note while these methodologies can potentially be used to create 

a forward-looking term rate that can complement SOFR, none of the methodologies can 

be used to create a forward-looking term reference rate that embeds credit risk. As 

discussed in Section II, the ARRC concluded that a term unsecured lending rate would 

not be a robust alternative to LIBOR given the limited transactions, unstable samples of 

borrowers, and sensitivity to market stress that these markets exhibit. And other than 

those rates, none of the other potential alternative rates (overnight repo rates, OBFR or 

EFFR, Treasury rates, central bank policy rates, and term OIS) include a meaningful credit 

component. 
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Because a transactions-based term rate will depend on an active trading market in SOFR 

derivatives, it will take some time to develop. The ARRC believes that this final step could be 

accomplished by the end of 2021. However, even under this timeline, it may be possible to build 

a demonstration rate earlier in the process that could help market participants to understand how 

the eventual term reference rate would likely behave. Further, it would still be possible to create 

a pre-determined, forward-looking payout structure in contracts referencing SOFR even prior to 

the creation of the term reference rate. For example, a party due to pay the average of SOFR in 

arrears at the end of the year could convert that payment to a set of pre-determined, forwardlooking quarterly payments by entering into a set of rolling quarterly OIS contracts. Thus, parties 

potentially paying or receiving a floating rate based on a compound average of SOFR do not 

necessarily need to wait for a term reference rate in order to maintain a LIBOR-like payment 

structure. 

Discussion 

The Paced Transition Plan maps out a clear and achievable strategy for creating a robust demand 

for trading SOFR derivatives. However, as already noted, the plan can only be successfully 

implemented if ARRC members and key end users and other market participants recognize their 

own interest in voluntarily helping to establish markets for SOFR instruments and building a 

critical mass of liquidity in them. To the extent that these goals are achieved quickly, a term 

reference rate based on SOFR derivatives could potentially be established earlier than the end of 

2021, which would enable many users of cash products to transition away from LIBOR at a faster 

pace if they chose to do so. If these conditions are met and there is demand to do so, the Paced 

Transition Plan could eventually be updated to incorporate faster adoption timelines or to 

incorporate explicit transition goals for some cash products. 

Successful implementation will require thoughtful adjustments to firms’ internal operational 

constructs to support the Paced Transition, and accepting SOFR OIS for clearing by CCPs and 

offering a SOFR-based PAI/discounting environment will require the support of clearing 

members and other liquidity providers. Regulators and self-regulatory organizations will also need 

to work cooperatively with market participants to ensure that there are no inadvertent hurdles that 

could inappropriately impede the development of SOFR markets. 

The ARRC has formed a Regulatory Issues working group, which has identified several areas in 

which regulators and self-regulatory organizations could aid the implementation of the Paced 

Transition Plan. Expedited regulatory approvals for CCPs that seek to clear new OTC products 

referencing SOFR would help to speed the transition plan. Releasing a longer history of repo data 

(which FRBNY has discussed doing) could aid in internal risk-modelling and potentially also in 

the capital treatment of SOFR-based instruments. And SOFR OIS will need to be added to the 

recognized list of benchmarks appropriate for hedge accounting, a step that the Financial 

Accounting Standards Board (FASB) is already actively proposing for consultation and expects to 
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

publish a final decision on in the near term.22 The decision by FASB to consider this step so 

quickly is a crucial one, and helps to set an example as to how much can be accomplished if the 

official sector and private market participants work cooperatively to support a smooth transition. 

Establishing new basis markets will also be important. Robust basis markets between SOFR, 

LIBOR, and EFFR will be needed to aid in a smooth transition and to support liquidity, and will 

require the support of ARRC members and all major market participants. Basis markets would 

also help to facilitate the voluntary closing out of legacy contracts. Cross-currency swaps and 

options referencing SOFR will also need to be established to help market participants hedge risks. 

The ARRC has formed a Market Structures working group to help establish basic prototypes for 

these new contract structures referencing SOFR and is working with ISDA and the Securities 

Industry and Financial Markets Association’s Asset Management Group to consult with market 

participants in designing them. A number of other infrastructures will need to be put in place, 

including establishing sources for market pricing and ensuring that SOFR derivatives are available 

for trading on SEFs and exchanges. 

 22 See 

www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176170063556&acceptedDisclaimer=true
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IV. ISDA’s Work on Contract Robustness for Derivatives

As discussed in Section I, the ARRC was tasked with considering best practices for contract 

robustness, and the ARRC has explored potential fallbacks for the rates it considered as 

alternatives to LIBOR. ISDA, a participant in the work of the ARRC, is leading a review of its 

documentation in order to improve contract robustness for derivatives, and many members of the 

ARRC are participating in ISDA working groups as part of this review.

The FSB’s Official Sector Steering Group (OSSG) has recommended that market participants 

both understand the contractual fallback arrangements that would apply if a benchmark such as 

LIBOR were permanently discontinued and ensure that those arrangements be robust enough to 

prevent potentially serious market disruptions in such an event. Current contract language for 

derivatives, which typically incorporate ISDA definitions, does not meet that standard. Under 

ISDA’s current definitions for interest rate derivatives, counterparties are directed to seek quotes 

from London or New York reference banks if LIBOR is not published. If two or more such 

quotes are obtained, the contract will pay the average rate, but if one or no quotes are received 

then the payment obligations are not specified. Most observers have noted that it seems unlikely 

that banks would be willing to provide these quotes, potentially leaving hundreds of trillions of 

dollars in outstanding derivatives contracts with no clarity on what they should pay or receive. 

Given that there are an estimated $190 trillion in outstanding derivatives contracts referencing 

USD LIBOR, this presents a key financial stability risk. Without a clear and practicable 

arrangement determining the rate that payments are to be based on, firms could be left with both 

potentially large and unplanned exposures, uncertain payment obligations, and many potentially

mismatched hedges. As LIBOR remains the dominant reference rate, new contracts are being 

written under the current ISDA definitions on a daily basis, adding to this risk. Market participants 

could mitigate this risk by closing out their current LIBOR transactions and moving new 

transactions to other rates, but to the extent that they continue to hold and use LIBOR 

instruments, it is important that more robust contract language be put in place. 

These issues are not specific to USD LIBOR. They are common across all of the currencies that 

LIBOR is quoted in as well as other benchmarks such as EURIBOR and TIBOR. Accordingly, 

in July 2016, the OSSG requested that ISDA lead a cross-currency initiative to improve derivative 

contract robustness to address risks of discontinuance of widely-used interest rate benchmarks.23

This work has two components: first, appropriately updating the ISDA definitions so that new 

trades would have more robust arrangements embedded in the documentation protecting 

investors against the risk that LIBOR may cease publication, and, second, to develop a method 

for incorporating similar types of arrangements into legacy contracts referencing LIBOR. 

ISDA has formed several working groups to consider these issues. They have identified 

appropriate conditions that should trigger a fallback and have identified SOFR and the similar 

alternative rates selected by each of the working groups in other jurisdictions as the appropriate 

 23 See Appendix C of the FSB’s 2017 Progress Report on Reforming Major Interest Rate Benchmarks. 
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SECOND REPORT OF THE ALTERNATIVE REFERENCE RATES COMMITTEE

primary fallback rate.24 Regardless of what rate was chosen as a fallback, it would be different 

from LIBOR, and there thus would need to be some method for adjusting for the difference 

between LIBOR and the fallback rate. Determining appropriate methods for calculating a spread 

or any other necessary adjustments to compensate for those differences is a key issue that ISDA 

is considering and will consult on before making any final recommendations. 

Although complex, this work is crucial and progress needs to be made with due speed, both for 

overall financial stability and for the mitigation of the risks faced by ISDA’s own members. 

Although many legacy derivatives contracts are due to roll off before the end of 2021 (Table 1), 

more risk is put into the system as new contracts continue to be written using the current ISDA 

definitions. If this language is not updated, it will be difficult for end users to mitigate their risks 

to LIBOR except by closing out their current positions. 

While the work that ISDA is undergoing will help to address a key financial stability risk regarding 

LIBOR in particular, the issue of contract robustness is more general. Users of financial 

benchmarks should seek to incorporate more flexible language that allows for practicable 

arrangements that are minimally disruptive in the event that the benchmark fails, especially in longterm contracts. ISDA’s work on LIBOR and other IBORs can potentially help set an example 

that may be useful in other contracts. 

As with the Paced Transition Plan, regulators can facilitate the adoption of more robust contract 

arrangements. The ARRC’s Regulatory Issues working group has noted several issues that 

regulators should consider, including whether adopting more robust contract language in legacy 

contracts would lead them to be treated as new trades, thereby triggering requirements to clear,

post margin, or be treated as a tax event. Hurdles of these types could impede the adoption of 

more robust contract language and thereby leave the system less safe overall. 

 24 See ISDA’s Benchmarks Initiatives, 2017 remarks by Scott O’Malia and Katherine Darras.
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V. Transition Issues for Cash Products

Since the announcement that FCA had sought to secure voluntary agreements from panel banks 

to continue submitting to LIBOR only through the end of 2021, participants in the many cash 

markets that use USD LIBOR are now searching for more robust contract language and 

considering transitions away from LIBOR. 

Although LIBOR was first created for use as a reference rate in pricing syndicated loans, over time 

its use expanded, and with that expansion its liquidity increased. Due to that liquidity, LIBOR 

became the dominant USD reference rate and is used in a wide array of cash instruments beyond 

syndicated loans, including many corporate loans, FRNs, securitizations, and some consumer 

mortgages and other loans. Much of USD LIBOR’s use in these instruments is due to the ease of 

hedging LIBOR in derivatives markets rather than any inherent need for a reference rate based on 

the cost of unsecured bank borrowing. Indeed, while the use of financial products referencing 

LIBOR has steadily grown, the actual volume of unsecured borrowing transactions underlying 

LIBOR has been in decline. And as shown in Figure 5, LIBOR has not historically been a very 

effective hedge of nonfinancial corporate borrowing rates. However, users of cash products have 

constructed complicated financing systems that rely on LIBOR in interconnected ways, and it will 

not be a simple task to orient those systems to a new rate. In particular, dealing with legacy 

contracts that reference LIBOR will be challenging, because most contracts for these cash 

products do not envision the possibility that LIBOR might permanently cease and have fallbacks 

that would not be economically appropriate if such an event occurred. And, unlike derivatives 

covered by ISDA documentation, these instruments are not generally covered by a standardized

documentation. Changing contract language in these cash products will require many bilateral 

negotiations. 

To better understand these issues, the ARRC formed working groups related to: 

i. Business Loans and Collateralized Loan Obligations

ii. Mortgages and Other Consumer Loans

iii. Floating Rate Notes

iv. Securitizations

Those working groups have already conducted initial research into exposures to USD LIBOR and 

the common forms of contract language in each of these sets of products. The groups’ initial 

findings for each of these sets of products are outlined below. 
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i. Business Loans 

Estimated Exposure to USD LIBOR

Among cash products, business loans have the highest exposure to USD LIBOR.

According to data from the Financial Accounts of the United States, as of the end of 2016, there 

were $3.4 trillion in outstanding private-sector loans to U.S. nonfinancial businesses (this figure 

excludes commercial mortgages and does not include committed lines of credit that have not been 

drawn on). Of the amount outstanding, $2.1 trillion are syndicated loans – loans that are jointly 

provided by a group of lenders to a borrower – according to Shared National Credit data. 

Based on Federal Reserve staff estimates, roughly 85 percent of corporate business loans are 

floating rate.25 A somewhat higher proportion of syndicated floating-rate loans appear to be tied 

to LIBOR than non-syndicated floating rate loans. As shown in Table 1, there are an estimated 

$1.5 trillion in outstanding syndicated loans referencing USD LIBOR and $0.8 trillion in 

non-syndicated loans. It is likely that there is also a roughly equal amount of exposure to USD 

LIBOR in committed lines that have not been drawn.26 

As of the end of 2016, there were also $4.1 trillion in outstanding commercial mortgage loans to 

U.S. nonfinancial businesses.27 As shown in Table 1, Federal Reserve staff estimates indicate that 

$1.1 trillion of this is tied to USD LIBOR. 

Many, though not all, business loan borrowers and lenders rely on USD LIBOR to hedge or offset 

their exposures in other products. For, example, in some instances borrowers are expected to also 

enter into derivatives contracts in order to limit the volatility of their floating rate payments. And 

there are an estimated $425 billion outstanding in collateralized loans obligations (CLOs) that 

securitize business loans (Table 4). 

Typical Contract Language

The contract language in business loan documentation may include instructions to seek quotes 

from a set of reference banks in the event that LIBOR is not published, similar to language in the 

ISDA definitions for derivatives, but if quotes are not obtained, then the language appears to 

typically imply that the rate paid on these loans would convert to an alternative base rate – either

the prime rate or a rate which is typically close to the prime rate and set at a fixed spread over 

EFFR. Because the prime rate is typically well above LIBOR (currently, 3-month USD LIBOR is

 25 The estimate of the proportion of floating rate debt is taken from The Potential Increase in Corporate Debt 

Interest Rate Payments from Changes in the Federal Funds Rate by Kumbhat, Palomino, and Perez-Orive, 

2017. Estimates of the proportion of loans tied to LIBOR are from Federal Reserve staff estimates based on 

proportions calculated using FR Y-14 data. 26 The amount of undrawn committed lines appears to be slightly larger than the amount drawn; for example, 

the amount of committed but undrawn syndicated loans is $2.2 trillion according to Shared National Credit 

data, while the amount drawn is $2.1 trillion. 

27 Financial Accounts of the United States – Z.1
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near 2 percent and the prime rate is 4.5 percent), this would entail a significant and unplanned 

increase in borrowing costs. 

In bilateral loans (the segment of loans that are not syndicated), the borrower and lender could

directly negotiate to change this term of the loan agreement. But while most details in syndicated 

loan agreement can be changed with the agreement of a majority of lenders, certain changes, 

including altering the rate, require unanimous lender consent. Thus it may be difficult to change 

these terms in some legacy syndicated loans, particularly in loans involving a larger number of 

lenders or institutional lenders that may not have a close relationship with the borrower.28 

However, roughly 80 percent of currently outstanding business loans will mature by the end of 

2021, and syndicated loans are amended fairly frequently, so it is very likely that most or all of the 

outstanding stock of loans would be amended before the end of 2021. New or amended contracts 

could include more robust fallback language or could be altered to refer to a specific fallback rate 

and method for determining adjustments to the spread on the loan in order to prevent a significant 

change in borrowing costs.

Working group members noted that they were beginning to see some variation in loan contract 

language at the initiation of both borrowers and lenders. Those variations were intended to 

introduce more robust language that would allow for a choice of economically appropriate 

fallbacks while seeking to minimize value transfers – for example, the type of transfers that would 

occur if the fallback caused a jump in rates paid by borrowers as in current language. Some of the 

language considered seemed to be aimed at limiting the discretion of the calculation agent, seeking 

to specify that the spread or margin of the loan should be adjusted to limit the valuation change 

from a change in reference rate. There was also a push by some market participants to move away 

from requiring unanimous consent to majority consent of the lenders to change the rate in 

syndicated loans. 

ii. Floating Rate Notes

Exposures to LIBOR

As noted in Table 1, as of last year, there were an estimated $1.8 trillion in FRNs referencing USD 

LIBOR. Of that amount, $1.1 trillion was debt issued by private sector businesses, with 

government-related entities (sovereigns, local governments, supranationals, and governmentsponsored agencies) having issued roughly $700 billion in floating-rate debt tied to USD LIBOR. 

A substantial portion, nearly $1 trillion, was issued by entities outside the United States. Issuance 

of USD LIBOR-tied FRNs is widespread across a range of countries, with the most significant 

amounts linked to entities from Europe, Japan and Canada. 

 28 Considering committed but undrawn credit agreements, borrowers would not be required to draw on those 

lines if the fallback rate was considered unfavorable, and uncommitted facilities would not pose problems since 

the lender would not be obligated to extend a loan. 
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However, while the outstanding stock of FRNs tied to USD LIBOR is substantial, roughly 84 

percent of those instruments are due to mature before the end of 2021 and 92 percent before the 

end of 2024 (Figure 8). Thus, there is scope to institute more robust contract language or to 

migrate away from LIBOR for a large proportion of this debt. Nonetheless, there is a small but 

still significant amount of debt that does not mature for very long periods of time, including 

existing notes that do not mature for 70 years or longer. 

Source: Bloomberg.

Typical Contract Language

Typical contract language in FRNs directs the calculation agent (often the issuer or the trustee) to 

first poll a sample of banks (similar to the fallback language in ISDA’s interest rate definitions for 

derivatives) if LIBOR is not published, and if quotes are not received then the note would convert 

to a fixed-rate instrument at the last published value of LIBOR. These terms can currently only 

be changed with the unanimous consent of all noteholders, which would likely be difficult to 

secure. In many instances, it might not even be feasible to locate the full set of noteholders. 

The inadvertent conversion of FRNs to fixed-rate instruments could be quite disruptive, both for 

the issuers and the holders of these notes, introducing a number of potential basis risks, less 

effective hedges, and potentially dramatically affecting valuations and the expected path of 

payments. In addition, some FRN investors, including money market funds, may be prohibited 

from investing in fixed-rate, long-term instruments. If LIBOR ceased to exist and FRNs 

0%

10%

20%

30%

40%

50%

60%

2018 2019 2020 2021 2022 2023 2024 2025-

2030

 2031-

2040

 2041-

2050

 2051-

2060

 2061-

2070

beyond

2070

Figure 8: Maturity Structure of Floating Rate Notes 

Percent Referencing US Dollar LIBOR

Year Maturing
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converted to fixed, those investors would be forced to sell their notes, resulting in losses to 

investors and a decline in the value of the notes.

In the absence of unanimous consent of note holders to change the terms of the contract, it is 

unclear how to avoid these disruptions. Issuers could attempt to buy back the current notes and 

issue new ones, but for some issuers, the current FRNs may be used as capital instruments and 

there might be nontrivial capital implications for the issuer in buying the notes back. Apart from 

buying back the notes, the best hope for addressing legacy contract risks in longer-dated FRNs 

might be some form of industry-wide solution. 

Market participants are considering a variety of contract language in new issuances. Some notes, 

for example recent FRNs issued by Goldman Sachs, JPMorgan Chase, and Morgan Stanley have 

offered different variations allowing the issuer, an affiliate, or a non-affiliate third party the right 

to name a market-accepted successor rate as calculation agent if any of the others fallbacks 

specified, including potential fallbacks to SOFR, were exhausted. Some other FRNs specified that 

the rate would fall back to the initial rate of the bond rather than to the last value of LIBOR. In 

those cases, participants preferred a fallback to a known rate rather than to some future value of 

LIBOR that was unknown at the date of issuance.

iii. Securitizations

Exposures to LIBOR

Amongst securitizations, mortgage-related products, including mortgage backed securities (MBS)

and collateralized mortgage obligations (CMOs), have the largest exposure to USD LIBOR, 

although most MBS and CMOs are fixed rate instruments and less than 10 percent ($967 billion) 

are tied to LIBOR (Table 4). In contrast, most collateralized loan obligations (CLOs) are tied to 

LIBOR, and CLOs represent the next largest amount of exposure to USD LIBOR at $425 billion.

Asset backed securities (ABS) related to student loans, credit cards, and auto and other loans and 

collateralized debt obligations (CDOs) together account for another $395 billion in exposure. 
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Table 4: Estimated Volumes of Outstanding Securitizations (Billions USD)

MBS and 

CMOs CLOs ABS CDOs Total

Total 10,298 503 725 182 11,708

of which: 

FIXED 9,217 22 444 24 9,707

LIBOR 967 425 243 152 1,787

Other 114 56 38 6 214

Source: SIFMA

Typical Contract Language

There is some variation in contact language across different types of securitizations. Agency MBS 

and CMOs constitute the largest share of securitizations; if LIBOR were permanently discontinued 

and other fallback methods such as polling reference banks fail to provide a fallback rate, these 

securitizations appear to generally allow the noteholder (Fannie Mae or Freddie Mac) to name a 

successor rate.29 Contract language in non-agency MBS is likely to be more varied, but it appears 

that typical contract language would require a poll of banks and then convert to fixed-rate at the 

last published value of LIBOR if quotes are not received. This language also appears to prevail in 

most ABS. Some ABS specify the trustee may have authority to name a successor rate, although 

it is unclear whether the trustee would consider itself able to do so. Changing the language in nonagency MBS or ABS would have to be approved by a noteholder vote, with different deals having 

different voter thresholds, but typically unanimous consent appears to be required. As with FRNs, 

securing unanimous consent, or even locating the full set of noteholders, would likely be quite 

difficult. Many securitizations also involve several different tranches, making the problem even 

more complicated. 

Standard contract language in CLO documentation similarly appears to imply that the CLO 

obligations currently paying LIBOR would become fixed rate instruments, paying the last 

published value of LIBOR, if LIBOR stopped publication. This would create potentially 

disruptive mismatches between the rate paid in the underlying loan securities (which would 

convert to the prime or a similar rate based on current contract language) and the rate paid on the 

CLO (which would convert to fixed) if LIBOR stopped. As with ABS and non-agency MBS, 

 29 See for example, www.fanniemae.com/syndicated/documents/mbs/remicpros/SF_FM_June_1_2014.pdf
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language in legacy CLO contracts would be difficult to change. However, while some CLOs can 

have maturities of 12+ years, most can typically be called after an initial 1-2 year period and almost 

always are, at which point more robust contract language could be included. For CLOs, one

possible change in language might be to set the fallback rate equal to the rate specified in the 

majority of underlying loans, but market participants are still only beginning to explore these issues. 

iv. Mortgages and Other Consumer Products

Exposures to LIBOR

As of the fourth quarter of 2016, the total amount of outstanding single-family residential 

mortgages was roughly $10.3 trillion.30 About 83 percent of these were fixed-rate mortgages and 

17 percent were adjustable-rate mortgages. An estimated $1.2 trillion of these adjustable rate 

mortgages are tied to USD LIBOR. According to data from the Financial Accounts of the United 

States, other consumer credit – which includes credit cards, auto loans, consumer loans and 

student loans – totaled $3.6 trillion, but the estimated exposure to LIBOR in these categories is 

relatively low. 

Typical Contract Language

Initial research indicates that mortgages generally have fairly robust language allowing the 

noteholder to choose a new rate if LIBOR was permanently discontinued. Language in 

conforming mortgages held or packaged in MBS by Fannie Mae and Freddie Mac give those

agencies the authority to name a successor rate in the event that LIBOR stopped publication. 

Mortgages not held by Fannie Mae or Freddie Mac also appear to typically have similar language 

giving the noteholder authority to name a successor rate, although there may be more variation in 

contract language in non-conforming mortgages. 

However, while contract language for most mortgages may give the noteholder the ultimate right 

to choose a successor rate, typical language is silent on how or if the margin or spread to the 

reference rate could be adjusted. Thus, if the noteholder named a successor rate that was higher 

than LIBOR, households could see an increase in their mortgage costs unless the margin was cut. 

There is no known precedent for raising the margin, but noteholders might have scope for cutting 

margin if the successor rate was higher. Fannie Mae has switched rates two times in recent history 

when minor reference rates were discontinued.31 In one case, the successor rate was slightly lower. 

In the other, the successor rate was very slightly higher and in that instance a servicer purchased 

all of the affected MBS pools, dissolved the MBS, and then modified the loans to avoid any 

increase in the loan rates to consumers. 

 30 Financial Accounts of the United States – Z.1 31 See www.fanniemae.com/portal/funding-the-market/mbs/news/2014/announcement-031214.html.
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VI. Conclusion – Looking Beyond LIBOR

As noted in Section I, the ARRC’s focus was directed toward developing plans to encourage 

voluntary adoption of its recommended rate rather than a mandated transition. Thus, while the 

Paced Transition Plan is designed to create a liquid alternative to LIBOR, it did not necessarily 

look beyond LIBOR in the sense that it envisioned that SOFR and LIBOR contracts might run 

in parallel for the foreseeable future. The work by ISDA to implement more robust fallbacks 

obviously acknowledges the risk that LIBOR could stop, but neither the ARRC nor ISDA took 

an end to LIBOR as a base expectation. And while the ARRC considered the potential for cash 

products to transition toward the rate that it would select, its work was focused on derivatives 

because they represent the vast majority of overall gross exposure to USD LIBOR and because, 

despite the warnings of the FSB and FSOC as to risks inherent to LIBOR, many market 

participants seemed likely to prefer to continue to reference LIBOR in cash products. 

However, the announcements from the FCA regarding the future of LIBOR have highlighted to 

many market participants the risk that LIBOR may cease publication at some point after 2021. 

The increased instability apparent in LIBOR has altered the trajectory of what market participants 

seek and need to accomplish. In some respects, this may encourage more active participation in 

the Paced Transition Plan as more market participants now understand that they may need to 

transition away from LIBOR. To the extent that more market participants begin to trade SOFR 

derivatives at earlier stages of the plan, the plan may proceed more quickly and a term rate could 

potentially be created before the end of 2021. At the same time, the potential that LIBOR might 

stop obviously accentuates the importance of the work by ISDA and the need to make contracts 

referencing LIBOR more robust, and has brought about a host of complicated decisions for users 

of cash products referencing LIBOR.

Although creating a financial system that does not rely on LIBOR may seem impossible to some, 

it is important to remember that LIBOR has only existed for 30 years. Transitioning away from 

LIBOR will pose many challenges, but it should be possible to do so in a way that minimizes more 

serious disruptions if market participants work cooperatively to avoid them. A clear, coordinated, 

and thoughtful process that openly engages with all market participants and involves the support 

of regulators in establishing fallbacks and transition plans is the best way to ensure that this occurs.

The official sector has clearly supported this type of process. The Federal Reserve Board’s 

Chairman Powell and CFTC’s Chairman Giancarlo have publicly pledged to work together with 

market participants in dealing with these transitions, and the FSOC has recommended that 

regulators and market participants collaborate in taking steps in mitigating any potential 

disruptions.32 The ARRC will continue to serve as a forum for encouraging this type of industrywide effort. As announced at the ARRC’s November 2017 roundtable, the Federal Reserve 

 32 See How to Fix Libor Pains, Wall Street Journal, August 3, 2017 and the FSOC 2017 Annual Report. 
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intends to reconstitute the ARRC in order to widen its membership and working groups to better 

coordinate between users of a variety of financial instruments who are now interested in mitigating 

their risks to USD LIBOR.33 

 33 The plan to reconstitute the ARRC was also announced on the ARRC’s website. See 

www.newyorkfed.org/arrc/announcements.html
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Appendix 1

With the support of a number of agencies including the U.S. Department of the Treasury, the 

U.S. Commodity Futures Trading Commission (CFTC), and the Office of Financial Research, 

the Federal Reserve Board and Federal Reserve Bank of New York convened the ARRC.34

The group was charged with identifying one or more alternative risk-free or nearly risk-free 

USD reference rates that both fit the needs of the market and meet standards of best practice, 

and with developing plans for the adoption of these rates. 

Membership of the Alternative Reference Rates Committee

Chair

Sandra O'Connor

Chief Regulatory Affairs Officer

JP Morgan Chase & Co.

Voting Members Nonvoting Members

Bank of America Bank of New York Mellon

Barclays CME Group

BNP Paribas DTCC

Citigroup ISDA

Credit Suisse LCH Clearnet

Deutsche Bank

Goldman Sachs

HSBC

JP Morgan Chase & Co.

Morgan Stanley

Nomura

RBS

Société Générale

UBS

Wells Fargo

Ex Officio Members

Board of Governors of the Federal Reserve System

Federal Reserve Bank of New York

U.S. Commodity Futures Trading Commission

U.S. Department of the Treasury

Office of Financial Research

 34 More information on the ARRC is available at the ARRC’s website.
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Appendix 2

The ARRC formed an advisory group in November 2016 as part of its efforts to solicit feedback

from a broad range of market participants. The advisory group provided input to the ARRC as it

finalized its recommendations for an alternative reference rate and transition strategy.

Membership of the ARRC Advisory Group:

BlackRock

Brevan Howard Asset Management

Citadel

GE Capital

Manulife

Met Life

Office of the NYC Comptroller, Bureau of Asset Management35

Pacific Investment Management Company

PNC Bank

Quicken Loans

The Federal Home Loan Bank of New York

The Federal Home Loan Mortgage Corporation

The Federal National Mortgage Association

The International Bank for Reconstruction and Development – World Bank

Verizon

 35 On behalf of NYC Pension Funds
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Appendix 3

This appendix illustrates a sample methodology for constructing a constant-maturity term rate 

from SOFR futures. As an example, we consider the construction of a 3-month rate on May 15, 

2015. 

The 3-month period in question (May 15 to August 15) included 2 Federal Open Market 

Committee (FOMC) meeting dates, June 17 (T1) and July 29 (T2). Allowing for discrete shifts in 

the overnight night rate after FOMC meetings, we can break the overnight interest rate into five 

distinct regime as shown in the figure below:

• R0 denotes the average of the overnight index in May up to the 15th.

• The overnight rate is assumed to be R1 every day between May 15 and June 17

• It is assumed to be R2 after June 17 until the next meeting on July 29

• It is assumed to be R3 subsequently until the end date (Aug 15)

• The overnight rate is assumed to average R4 for the portion of August after the 15th.

.

For each rate Ri and calendar month Mj we denote by fij the fraction of month Mj that has the 

overnight rate equal to Ri (e.g., f01 equals 14/31, since R0 spans 14 days in the month of May 

(month M1) and f11 equals 17/31, since R1 spans the remaining 17 days in the month).

If we denote by FF1, FF2, FF3 and FF4 as the values of 100 minus the futures prices for May, June, 

July, and August respectively, we can setup a system of equations linking the overnight rate regimes 

with observed forward rates from the calendar month futures contracts. The equations can be 

written in matrix form as Ax = b, as shown below. The first equation also requires R0 to take the 

value of the observed historical average of the overnight rate in the current month, which we 

denote as FFact
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Based on the data prevailing on May 15, 2015, the equation would look like this:

Once the equation is solved, the overnight rates can be compounded daily over the desired term 

to produce the necessary term rate. However, in general, the equation may not be always directly 

solvable – there may be more variables than equations, or the matrix A may have properties that 

admit no solution or infinite solutions. Even when the system can be directly solved, it may be 

that small variations in futures prices can produce big swings in solved rates, particularly when the 

trade date is close to a meeting date or month end. 

In this example, we use an approach that seeks to approximately solve Ax = b, while also imposing

additional structure on the solution. Solutions where the overnight rate shifts up after one 

meeting, while shifting materially down after the next, are rather unlikely to be baked into

expectations. Such solutions can be penalized by solving the problem

Where M is a constant, e denotes the vector of ones and H denotes the Hessian matrix 

associated with the penalty function. 
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We also modified entries in A so that values below a threshold (0.1) were rounded down to zero, 

and the remaining elements in the row were scaled up so the sum equaled 1.

This methodology was implemented for 3-month and 6-month tenors, with results shown 

below. As can be seen, the results are quite close to historical EFFR OIS rates.