Accelerating momentum to get market participants to switch from the LIBOR benchmark rate to an alternative reference rate, the CFTC Market Risk Advisory Committee (MRAC) adopted the "SOFR First" initiative as a market best practice. SOFR First lays out a phased framework to switch trading conventions from LIBOR to the Secured Overnight Financing Rate (SOFR) for various U.S. Dollar (USD) derivatives instruments.
The committee’s SOFR First recommendation, along with earlier committee recommendations on plain English disclosures for new derivatives contracts referencing LIBOR and a CCP discounting transition tabletop exercise, will be submitted to the Commission for consideration.
Acting Chair Rostin Behnam issued a statement in support of SOFR First, saying he plans to have staff present the Commission with a rule proposal addressing mandatory clearing of SOFR swaps, with the expectation of finalization in 2022.
CFTC staff issued a statement that although the committee’s SOFR First adoption is not Commission nor Division action, the Divisions "strongly encourage" market participants and SEFs to consider following SOFR First.
SOFR First. The phased initiative was developed by the Interest Rate Benchmark Reform Subcommittee to help market participants decrease reliance on USD LIBOR in an orderly manner. The Financial Stability Board and the International Organization of Securities Commissions on LIBOR transition have backed U.S. banking regulator guidance that banks need to stop entering new contracts that reference USD LIBOR as of December 31, 2021.
SOFR First has four phases:
- Phase 1: Starting July 26, 2021, interdealer brokers would replace trading of LIBOR linear swaps with trading of SOFR linear swaps. SOFR First recommends keeping interdealer brokers’ screens for LIBOR linear swaps available for informational purposes, but not trading activity, until October 22, 2021. After that, the screens should be turned off altogether.
- Phase 2: Starting September 21, 2021, SOFR First recommends switching cross-currency swaps.
- Phase 3: At a date to be determined by the committee, SOFR First recommends switching swaptions, caps, floors, and other non-linear products.
- Phase 4: At a date to be determined by the committee, certain futures contracts and other exchange-traded products would be encompassed in the phase-in, giving due consideration to supervisory guidance and USD LIBOR’s cessation date.
Behnam stated that he plans to have staff present the Commission with a rule proposal addressing mandatory clearing of SOFR swaps, with the expectation of finalization in 2022.
Behnam also stated that for purposes of the Commission rule prohibiting post-trade name give up (PTNGU) on swap execution facilities (SEFs), which is now applicable to swaps that are mandatorily cleared or intended to be cleared, Commission staff expects that SEF’s will treat SOFR swaps as intended to be cleared or as mandatorily cleared swaps for purposes of Commission Rule 37.9(d).
CFTC staff noted that the timelines for the end of all LIBOR panels are now clear. Given risks to market stability and integrity as well as many risks for market participants, the cessation of and transition away from LIBOR remains one of the Divisions’ significant regulatory priorities.
Accordingly, staff stated that the use of LIBOR rates in new contracts should, with very limited exceptions be ceased as soon as practicable and no later than December 31, 2021. Further, staff recommends that market participants should accelerate their conversion of legacy LIBOR contracts and SEFs should continue to focus on efforts to build liquidity in alternative reference rates in their markets.
Regarding SOFR First, although it is not binding, staff "strongly" encouraged market participants and SEFs to consider following SOFR First as a market best practice. Staff also urged market participants and SEFs to monitor the transition away from other IBOR rates relevant to their businesses.
Commissioner Stump’s concerns. Commissioner Dawn Stump said that while she "wholeheartedly" supports mandatory clearing as an important element of the post-financial crisis reforms, as the use of LIBOR ceases, all of the CFTC’s clearing mandates for interest rate swaps need to be revisited.
Stump noted that the CFTC implemented its Dodd-Frank clearing mandates and requisite clearing infrastructure updates ahead of other jurisdictions. As a result, these regulations were always meant to be a "temporary state" that would need to be revisited as other jurisdictions adopted their own measures.
"[C]ontinuing to mandate clearing of any specific product, while at the same time disallowing access to a robustly regulated, non-U.S. clearinghouse providing the type of liquidity U.S. clients seek to most effectively comply with the mandate to clear that product, is a critical issue that can no longer go unaddressed," said Stump.