It's been said a thousand times, but Libor's days are numbered. Ever since the Bank of England established a shelf life for the interest rate of December 21 2021, efforts to replace it have been gaining pace.
Across the world, the finance sector has seen alternative rates crop up, each designed independently and with their own sets of pros and cons. To name but a few; the UK has Sonia, the EU €STR, Japan has Tonar and in the US, the NY Fed has been working hard to develop the Secured Overnight Financing Rate (SOFR).
However, over the course of the last year or so, what appeared to be a straightforward like-for-like process has become more complex. In the US at least, the discussion of how best to replace USD Libor is no longer focused solely on SOFR, but has evolved into something of a patchwork of various rates that each perform in different ways and provide different functions to different sectors of the market.
See also:Primer on SOFR
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One such alternative-alternative rate is the American interbank offered rate – or Ameribor – which is published by the American Financial Exchange (AFX), a self-regulated electronic exchange on the CBOE platform that launched in 2015.
What is Ameribor and what does it do?
According to Ameribor's website, it is a new interest rate benchmark that reflects the actual unsecured borrowing costs of banks and financial institutions.
"While useful in their respective markets, neither Libor nor SOFR serve the requirements of the thousands of banks across America which do not borrow at either Libor or SOFR to fund their balance sheets. These banks need a separate and distinct benchmark that reflects their actual borrowing costs. This benchmark is Ameribor."
While SOFR is based on secured – or collateralised – loans, Ameribor contains a credit spread component based on unsecured loans, meaning it is more representative of the cost of funding for certain banks.
Why should there be multiple rates?
The London interbank offered rate served multiple purposes. As a multifaceted rate it was applied to financial instruments and contracts in every corner of the world. Now that the time has come to replace it, there is a strong and cohesive school of thought that argues in favour of multiple rates to replace one: why pick one when you can have several that are cut to fit.
According to Richard Sandor, the founder of Ameribor and the chairman and CEO of the American Financial Exchange, having multiple benchmarks will enhance market efficiency, innovation and drive down transaction costs.
"Multiple rates will also lead to greater innovation. AFX connects borrowers and lenders across the US, creating, for the first time, a national market for unsecured lending. AFX now has its data on the blockchain, a first-of-its-kind initiative to provide greater transparency to market participants, regulators and academics," he told IFLR.
Christopher Giancarlo, previous chairman of the Commodity Futures Trading Commission and member of the AFX board of governors, agrees. "I believe, as many do, that there is no reason why Libor – having been a singular rate – should be replaced by a singular rate," he says. "If you look at almost all areas where benchmarks are prevalent, there is a range of benchmarks in all of the asset classes."
How does it work?
Using the CBOE platform AFX, Ameribor is effectively an index of the credit weighted average of its member's unsecured loans. AFX connects borrowers and lenders across the US, creating a national market for unsecured lending. AFX stores its data on the blockchain in an effort to provide greater transparency to market participants, regulators and academics.
"Unlike other markets that only provide time, quantity and price transaction information, AFX now has records with additional data fields related to each transaction," says Sandor.
This additional data includes: the entire order book at the time of each transaction; the geographical region of the counterparties to each transaction; and detailed counterparty information such as credit rating, type of institution, and detailed financial metrics for each counterparty.
Ameribor is quoted on an actual/360 day-count, following business day convention and rounded to the fifth decimal place.
Who uses it?
More than 1,000 US banks and financial institutions are currently members of the AFX and use Ameribor, largely in the small to midsize category. John Deere and American Electronic Power have both recently become members, and this month Citizens Financial Group, one of the US' 20 largest banks with assets of $177 billion, joined the exchange.
What does it do that SOFR doesn't?
As previously stated, when compared to SOFR, the big difference between the two rates is that Ameribor contains a credit spread component based on unsecured loans. This means that the rate is more suitable for small to midsized banks that are less likely to use secured loans.
See also in Practice Insight: Midsized banks say don’t impose SOFR on us
Away from the very largest institutions, not many US banks have large enough pools of treasuries from which to borrow money to cover overnight funding. "We don't have huge investment portfolios sitting around like broker-dealers do. Most banks, including many large banks, don't have large pools of investment securities from which to borrow,” says Tom Broughton, president and CEO of ServisFirst Bank, a Birmingham, Alabama-based bank with around $8 billion in assets.
“It’s very simple: SOFR is not reflective of banks’ cost of funds, whereas Ameribor is.”
Scott Shay, chairman at New York-based Signature Bank, which had just under $50 billion in assets in 2019, stresses the importance of letting the market decide on indexes, adding that there should not be a set – or big bank-imposed – index for any firm of any size.
“Any index that is Iosco-compliant should be given safe harbour when Libor passes out. The reason banks like ours like Ameribor is because anyone can participate in it. It is publicly traded in a publicly viewable financial market, and it is related to unsecured lending costs,” he says. “We want to use this as a secured placeholder for unsecured lending.”
Using an index based on secured financing makes very little sense for secured midsized banks. “If the big banks want to use it among themselves we have no objection, but we don't know why this has anything to do with Main Street,” adds Broughton.
Has it been ratified at the regulatory level?
Although AFX has been publishing Ameribor since 2015, it has only recently risen to prominence. In late May, Federal Reserve chair Jerome Powell issued a statement to Senator Tom Cotton confirming that market participants are able to choose the rate that most suits their needs.
This came in direct response to concerns that SOFR is not credit-sensitive, unlike Libor. “We have been clear that the ARRC’s recommendations and the use of SOFR are voluntary, and that market participants should seek to transition away from Libor in the manner that is most appropriate given their specific circumstances,” wrote Powell.
See also in Practice Insight: Interview with ARRC Chairman Tom Wipf
Following this, on June 25, AFX announced a record volume milestone, reaching $1 trillion in transactions since inception.
Ameribor is also compliant to Iosco's 19 Principles for Financial Benchmarks, which are reviewed and audited by an independent third party.
Is it forward-looking?
Under Libor, banks are able to make loans based on the average interest rate across seven different maturities; overnight, one week, and one, two, three, six, and 12 months.
At present, one of the most pressing issues with SOFR is that it does not have a forward-looking term rate that can be comparable to Libor.
Ameribor also does not have a term rate akin to Libor. Both SOFR and Ameribor have listed futures contracts that can be used to provide inter-commodity spreads to the trading community on a seven-day and three-month basis.
This will allow banks to hedge the interest rate exposure of biweekly Federal Reserve System reserve requirements by using seven-day futures contracts, and allow users greater exposure to future interest rate volatility.
See also in Practice Insight: UK loan market braces itself for world without term rates