A U.S. regional bank uses USD LIBOR across business lines that require a floating reference rate, including trade finance, loan syndications, residential mortgages, and corporate finance. The bank also issues floating rate notes (FRNs) as part of its funding strategy and uses OTC derivatives to hedge its book and to facilitate loans to clients.

The bank’s risk management and Treasury teams (its LIBOR transition program leads) have been formulating strategies to best position its businesses and manage its asset/liability mix. They are selectively operationalizing alternative reference rates (ARRs) ‒ including CME Term SOFR, formally endorsed by the Alternative Reference Rates Committee (ARRC) in 2021 – and preparing product pricing and capital cost scenarios.

CME Term SOFR Reference Rates are daily forward-looking interest rate estimates published for 1-month, 3-month, 6-month, and 12-month tenors. Derived from CME SOFR futures, CME Term SOFR provides a robust and resilient underlying data set based on market expectations implied from derivatives markets.

To enable a seamless transition from USD LIBOR to CME Term SOFR, the bank must be prepared to optimize its choices across products and clients. Bank clients include Fortune 250 corporates, middle market borrowers, and community banks whose own preparedness for the transition from LIBOR varies considerably. These choices may have material bottom-line implications.

The bank’s legal team has implemented a contractual remediation process that follows regulatory guidance regarding fallback provisions and amendments to legacy deals, being mindful of New York state and federal legislative solutions. The bank manages the cost of capital and strategic corporate finance considerations using a “fast follower” process. For example, monitoring its peers’ markets and opportunistically adjusting or implementing strategic choices.

The bank’s transition objectives include:

• Maintain/enhance competitiveness across business lines.
• Adhere to regulatory guidance.
• Optimize liquidity and capital flexibility.
• Ensure transparent funds transfer pricing (FTP).
• Be prepared to execute legacy transaction waterfall provisions.

Over several months, the bank collects market intelligence to understand likely outcomes. This includes discussion with market leaders across asset classes, clients, regulators, and market infrastructure providers such as CME Group, software platforms, and risk advisors, to:

• Identify, for each business line/asset class, the most likely ARRs to be used and the implications.
• Understand ARRC’s guidance regarding cash and derivative products based on ARRs.
• Determine action plans needed to build execution readiness capability.
• Proactively manage contractual remediation for deals expiring after June 30, 2023.

As a result, the following determinations have been made:

• U.S. syndicated loan and trade finance markets are evolving quickly to prioritize CME Term SOFR.
• Commercial real estate lending market is also gravitating to CME Term SOFR as the ARR of choice.
• For many months, floating rate notes (FRNs) ‒ driven by the FHLB System, Fannie Mae, and Freddie Mac ‒ have referenced published SOFR averages, set in arrears and using simple and compounded averages.
• For over a year, residential mortgages ‒ also driven by Fannie Mae and Freddie Mac ‒ have been mostly indexed to SOFR averages computed in arrears, set in advance.
• Clients may wish to use OTC derivatives to hedge CME Term SOFR exposure from these loans.
• The bank formulates its action plan to include permissible uses of CME Term SOFR OTC derivatives, to continue their role in facilitating client loans.
• CME Term SOFR licensing requirements and process were clarified, so that the bank has the information it needs to proceed regarding cash and derivative products.
• Some smaller, less sophisticated, and more highly leveraged corporates are more likely to use CME Term SOFR. Some borrowers may require licensing, if they engage in activities entailing the use of CME Term SOFR.
• Given that most legacy transactions provide for CME Term SOFR at the top of the post-LIBOR waterfall, asset classes that currently use SOFR averages (e.g. mortgages) may transition to CME Term SOFR over time.

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