ARRC adjustable-rate mortgages white paper further boosts IBOR transition

Author: John Crabb | Published: 11 Jul 2019
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small housesThe Alternative Reference Rates Committee (ARRC) released guidance Thursday afternoon on how the Secured Overnight Financing Rate (SOFR) can be used when issuing newly adjustable-rate mortgages (ARMs). The move was welcomed by other members of the US financial regulatory arena, including the Federal Housing Finance Agency (FHFA), the Federal Reserve and the Consumer Financial Protection Bureau (CFPB).

The ARRC, a group of private-market participants established by the Federal Reserve Board and the New York Fed. Their guidance highlights the key points to consider when using SOFR in newly issued ARMs as they relate to borrowers, originators, servicers and investors.

Federal Reserve vice chair for supervision, Randal Quarles, said: "The official sector has emphasised the need to move away from Libor, and it is encouraging to see the ARRC and leaders in the mortgage industry putting forward creative solutions that offer consumers competitive alternatives."

"This work demonstrates that it is possible to develop new options for consumers using SOFR that can be made available well before the end of 2021, when Libor may stop," he continued.


"It is possible to develop new options for consumers using SOFR that can be made available well before the end of 2021"


The white paper itself highlights the thoughts of the Consumer Products Working Group. Among other considerations, it suggests that these financial products should either explicitly or implicitly use an average rate SOFR, not a single reading of the overnight rate, in determining payments on floating-rate instruments.

It also says they should not use SOFR in arrears because consumers would be given very short notice periods; and, states that new ARM product based on SOFR should be structured to fit the needs of consumers and be offered at rates and terms consistent with, and as determined by, the competitive markets in which they are transacted.

See also: CFPB likened to predator-protection agency under Kraninger's watch

Consumer first

These consumer focused moves, intended to ensure that the industry stays competitive yet fair for mortgage buyers, were welcomed by the new CFPB director Kathleen Kraninger. Kraninger has been widely criticised since she was confirmed as the permanent director, with Dennis Kelleher of Better Markets suggesting that,  under her leadership,  the CFPB: "is being transformed from a consumer protection agency into a predator protection agency". 

That being said, the ARRC's move has drawn a positive reaction from Kraninger. "The CFPB is committed to working with the other ex-officio members of the ARRC to help the market successfully transition away from Libor," she said.

"Today’s release of the white paper relating to adjustable rate mortgages by the ARRC is an important step in helping all market participants, including consumers, to move away from Libor in a transparent, orderly, and fair manner."

Tom Wipf, chairman of the ARRC and vice chairman of institutional securities at Morgan Stanley, said that the white paper demonstrates SOFR can be used to benefit consumers. "The paper shows that there are ways to avoid subjecting consumers to the risks inherent in Libor. It is possible to use SOFR now to develop products that are built on a robust reference rate that is firmly grounded in market transactions," he said.

See also in Practice Insight: Libor fallbacks still not aligned across products

New ground

This is the ARRC's first move to ease the transition at the consumer level, with previous iterations looking at investor grade concerns such as  securitisation, derivatives or bi-lateral business loans. Previously the guidance has been in the form of fallback language that can be used to recalibrate existing contracts that reference IBORs so that they reference SOFR instead.


"It is possible to use SOFR now to develop products that are built on a robust reference rate that is firmly grounded in market transactions"


Today's white paper, however, addresses how US residential ARMs, and those in other countries referencing US markets, can initiate a new SOFR based product from the outset. There are issues however, such as the suggestion that the less representative rates could push up initial rates for newly-issued SOFR based ARM products.

FHFA principal deputy director, Adolfo Marzol, commended the work of the ARRC and the release today of the white paper outlining a framework for developing newly-originated consumer residential products. "The FHFA is committed to the important work of developing a path to a successful transition away from Libor," he said.

This release is yet another example of the Fed and the New York Fed taking steps to ensure that it stays ahead of the curve in making sure it is prepared when the time inevitably comes.

See also in Practice Insight: Loan market still concerned by lack of term Libor replacement