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Opinion

Libor: Sonia and Sofr need term rates too

The regulators want overnight rates to become the norm in all markets after Libor – that could be wishful thinking.

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JPMorgan was in the market in late July with a $2.25 billion preferred stock deal. The non-call five notes pay a fixed rate of 5% until August 1, 2024, and then switch to a floating rate of three-month term secured overnight financing rate (Sofr), plus a spread of 3.38%.

The only problem is that three-month term Sofr doesn’t exist.

This is the first bank capital trade to reference Sofr. Bank of America issued a $1.3 billion Series KK preferred deal at the end of June, but that was still benchmarked to Libor.

Wells Fargo, JPMorgan, Citi, Goldman Sachs and Morgan Stanley have all issued senior notes that reference overnight Sofr, but not a term rate.

There are many good reasons to use an overnight rate in the cash market as well as for derivatives. It frees borrowers from exposure to bank credit risk and aligns lenders to the derivatives that they use to hedge their lending.

Indeed, using overnight rates is an opportunity to remove the basis risk that exists between the cash and derivatives markets.

For this reason, the development of alternative reference rates to replace Libor has so far focused on overnight substitutes.


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