Investors Closer to Getting a Credit-Based Alternative to Libor

LONDON (Capital Markets in Africa) — Global regulators’ approval of a U.S. dollar-denominated rate that assesses market credit risk is growing nearer as the beleaguered London interbank offered rate is set to be phased out, allowing financial service firms to fill the void with new benchmarks.

Bloomberg’s Short-Term Bank Yield Index, or BSBY, adheres to the International Organization of Securities Commissions’ Principles for Financial Benchmarks, based on an independent assurance review, Bloomberg LP said in a statement Tuesday. A final report is expected soon.

Bloomberg LP, the parent company of Bloomberg News, created the index as a potential rival to benchmarks such as the Secured Overnight Financing Rate, ICE Benchmark Administration’s Bank Yield Index and Ameribor.

Since the Alternative Reference Rates Committee identified the SOFR, as the presumptive heir to Libor, market participants have complained that the new index doesn’t capture credit risk or have a forward-looking term structure. These missing pieces are likely contributing to SOFR’s tepid use and the recent growth in the amount of products linked to Libor despite the benchmark’s impending end.

A step toward approval of Bloomberg’s BSBY index “does challenge the market’s embrace of SOFR and signals that the market will want to embrace a forward-looking credit-sensitive dynamic,” said Mark Cabana, head of U.S. interest-rate strategy at Bank of America Corp.

BSBY is constructed using aggregated and anonymized data based on transactions of commercial paper, certificates of deposit, U.S. dollar bank deposits and short-term bank bond trades, reflecting banks’ marginal funding costs. The rate includes a systemic credit spread and term structure, two components SOFR lacks, though Bloomberg has said BSBY can also be used as a supplement to term SOFR.

The ARRC — a collection of public- and private-sector participants tasked with overseeing the Libor transition in the U.S — said last month that it can’t recommend a forward-looking term rate for the Secured Overnight Financing Rate by mid-2021 or guarantee one even by year-end because of insufficient liquidity in derivatives tied to SOFR. This was considered the final piece of the transition and what many market participants have been waiting for.

This credit-sensitive benchmark is most alluring for investors in short-dated securities, such as money-market funds that are currently searching for any product that generates yield in a zero-interest-rate environment. That’s something SOFR doesn’t offer as it has been stuck at 1 basis point since March 11.

The BSBY index “offers more potential for spikes and higher rates in a way that SOFR doesn’t,” Cabana said. “That’s why money funds were loving floaters based off of SOFR in the middle of 2019 because SOFR had this spiking potential at the end of the month. Anything that has credit sensitivity offers the potential for those spikes.”

Debbie Cunningham, chief investment officer for global money markets at Federated Hermes Inc. in Pittsburgh, expects issuers to eventually use the BSBY index in short-term corporate IOUS such as certificates of deposit, commercial paper, and medium-term and floating-rate notes.

Now it’s a matter of whether BSBY has enough appeal to siphon market activity from SOFR or other established reference rates. Market participants are also awaiting the debut of the ICE Benchmark Administration’s Bank Yield Index, which is similar to BSBY in that it is based on unsecured bank funding transactions.

“I guess the question is what kind of share it takes off SOFR or the fed funds market,” said Blake Gwinn, head of U.S. interest rates strategy at NatWest Markets. “Is it going to end up being like three similar-sized markets, or will BSBY be the new Libor with the other two as niche?

Source: Bloomberg Business News