How The Transition Away From LIBOR Is Actually Going

Tracy Alloway (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:16)

And I'm Joe Weisenthal.

Tracy Alloway (0:18)

So Joe, I think on our last recording of our LIBOR series, I think I said that that was actually the last episode, but you know what? That was advertising.

Joe Weisenthal (0:31)

You could just, there's never enough LIBOR is there.

Tracy Alloway (0:33)

No, and also it's kind of amazing, but as we continue to record these episodes, more and more people want to actually talk about LIBOR. And I guess it kind of makes sense after all, this is the reference rate that affects, you know, I can never keep track, but I think it's something like $350 trillion worth of assets.

So obviously it's absolutely crucial for the financial system.

Joe Weisenthal (0:58)

Right, I mean, yeah, as you say, it makes sense that people have so much to say about it, given that it's been so crucial to the pricing of trillions, hundreds of trillions of dollars worth of assets, and it's this sort of Herculean task to sunset it in some way and transition to something else. So I don't know, maybe we should do like a month-long LIBOR series.

Tracy Alloway (1:23)

Look, we have two more episodes scheduled, including this one. So let's do those first, and then we can talk about maybe doing a month-long LIBOR series.

Joe Weisenthal (1:31)

Okay, and we'll revisit.

Tracy Alloway (1:33)

Okay, but I'm really happy to say that today, for our guest, we have someone who's actually, you know, personally involved in the transition process from LIBOR to SOFR.

SOFR, of course, is the Secured Overnight Financing Rate. If you don't know what that is by now, then you should go back and listen to some of our previous episodes, but it's basically the thing that's supposed to replace LIBOR. So it's gonna be really interesting to talk about the thinking behind that transition process, but also how it's actually going.

Joe Weisenthal (2:06)

Great. I'm really excited about this, because again, I do like a lot of our talk. I like when we have discussions on anything that are actually not just sort of theoretical, but deal with these sort of nuts and bolts with how you actually do something.

Tracy Alloway (2:21)

Yeah, this is definitely a practice. So, okay, let's bring on our guest for the episode. It is Tom Wipf, who is chair of the Alternative Reference Rates Committee and also vice chairman of Institutional Securities at Morgan Stanley. Tom, thanks so much for coming on.

So, Tom, maybe just to begin with, you could give us a sort of brief description of what the Alternative Reference Rates Committee or the ARRC actually does. When was it started and what's the goal?

Tom Wipf (2:55)

So, really, the ARRC was put together in 2014, originally, to begin to select an appropriate durable alternative to LIBOR and then to put forward a plan to actually get off LIBOR and on to that new rate.

That work continued for several years, and at that point, that group selected SOFR, which is the Secured Overnight Financing Rate, which is basically the US Treasury repo market reported over a trillion dollars a day in daily activity and transactions. And that really solved to the first problem because if you go back to the history of LIBOR, that the issues developed because the interbank market itself had shrunk tremendously over some period of time.

Additionally, the use of LIBOR had gone up exponentially. And you sort of can take that from sort of the mid 1980s all the way up until 2012 and the scandals that emerged from that. But so much of that was based on the fact that the underlying transactions in the inner dealer market had reduced considerably, use had gone up. And you get this concept of the inverted pyramid, which is too few transactions supporting too many financial contracts. And without transactions to create those rates, submitting panel banks who create LIBOR were forced to use what they call expert judgment.

So when we decided on SOFR, the first thing we tried to solve to was, can we find something that has sufficient underlying transactions that would mean that there would be really no need for expert judgment, but in fact, we could just rely on actual trades to create the rate.

Joe Weisenthal (4:36)

From your perspective, as you say, one of the nice things about SOFR is there's actual trades, there's no ambiguity, no less opportunity to manipulate the number. What in your view is the primary challenge and what is the work that you do to enable this transition from one index to another?