Committee on Alternate Reference Rates (ARRC)

Committee on Alternate Reference Rates (ARRC)

What Is the ARRC (Alternative Reference Rates Committee)?

The Federal Reserve Board and the New York Fed formed the Alternative Reference Rates Committee (ARRC). Its members include private-sector banks, asset managers, insurers, and trade groups in the financial industry. The committee's purpose is to "enable a smooth transition from USD LIBOR to a more robust reference rate," namely the Secured Overnight Financing Rate, or SOFR.

• The London Interbank Offered Rate, or LIBOR, was formerly a major benchmark for determining worldwide interest rates.
• A rate-rigging scam was revealed in 2012, and financial regulators began phasing out LIBOR.
• The Federal Reserve Board and the New York Fed formed the Alternative Reference Rates Committee (ARRC) to develop a new benchmark to replace LIBOR.

Committee on Alternate Reference Rates (ARRC)

Understanding the Committee on Alternative Reference Rates (ARRC)

The London Interbank Offered Rate, or LIBOR, was formerly a significant benchmark in establishing interest rates throughout the world, but after a rate-rigging scandal surfaced in 2012, banking regulators decided to phase it out and replace it.

The Federal Reserve Board and the New York Fed formed the Alternative Reference Rates Committee (ARRC) in the United States to suggest and assist in the implementation of a new benchmark to replace the LIBOR.

The American Bankers Association, Bank of America, Goldman Sachs, JPMorgan Chase, MetLife, and Wells Fargo are among the private-sector members of the AARC. Ex-officio members include the Consumer Financial Protection Bureau, the Federal Deposit Insurance Corporation, the Federal Reserve Board, the National Association of Insurance Commissioners, and the United States Securities and Exchange Commission.

The Alternative Reference Rates Committee's History (ARRC)

In 2014, the Alternative Reference Rates Committee (ARRC) began its work. Its initial assignment was to propose a new benchmark rate to replace the LIBOR. In 2017, it proposed replacing LIBOR with the Secured Overnight Financing Rate (SOFR).

The SOFR is based on the interest rate that financial institutions pay each other to borrow cash overnight in transactions secured by US Treasury securities. 3 Because these transactions are visible, the SOFR is seen to be less susceptible to manipulation than the LIBOR, which is frequently based on guesses. 4 The SOFR is also based on many more transactions than the LIBOR, making it more solid.

The AARC chose SOFR above other prospective standards because "moving the financial industry off of LIBOR is a very difficult and costly process; thus, avoiding the need for another transition in the future was vitally essential to the ARRC." The AARC stated that, in addition to achieving its other selection criteria, SOFR "stood out for having the greatest number of underlying transactions It is also the widest gauge of the market it covers, putting it in the greatest position to remain stable even while the underlying market changes. The Treasury repo market is particularly durable, as the ARRC anticipates it to persist for as long as the US Treasury issues debt."

The 2018 LIBOR to SOFR transition schedule was published by the AARC. In accordance with that plan, the Federal Reserve Board of New York released its first SOFR rate data on April 3, 2018, in coordination with the Office of Financial Research in the Treasury Department. Additionally, it offered data forecasting SOFR rates back to August 2014 based on modeling.

The AARC's roadmap aimed for LIBOR to be completely phased out by December 31, 2021. LIBOR was eventually phased out when SOFR was established. The ICE Benchmark Administration, which regulates LIBOR, said that it will cease publishing most LIBOR rates on December 31, 2021, and the remainder by June 20, 2023. (LIBOR was not a single rate, but rather a collection of up to 35 rates depending on five national currencies and seven tenors, or maturities, of bank loans.) The deadline of June 2023 contains two USD LIBOR rates: overnight and 12 months. At that moment, the SOFR rate will be independent.

Every business day at 8 a.m., the New York Fed releases the most recent SOFR on its website. It also provides three compounded averages of the SOFR, with tenors of 30, 90, and 180 days, as well as a SOFR index that may be used to determine compounded average rates over different time periods, in addition to the overnight rate.

With the demise of the LIBOR, other countries' central banks have had to decide on alternative standards and have created committees such as AARC to assist in steering the process. In the United Kingdom, for example, the Bank of England's Sterling Overnight Index Average, or SONIA, was chosen to replace the LIBOR in 2017.

According to the AARC website, the committee "seeks to coordinate its efforts with these other groups to the greatest extent feasible."

Committee on Alternate Reference Rates (ARRC)

What Is the Secured Overnight Financing Rate (SOFR) and How Is It Used?

Like the LIBOR before it, lenders use the Secured Overnight Financing Rate (SOFR) to determine interest rates on consumer and business loans. For instance, the lender will take the current SOFR and add a margin in the form of additional percentage points to determine the interest rate on an adjustable-rate mortgage (ARM).

That LIBOR Scandal: What Was It?

In order to increase or decrease the reported London Interbank Offered Rate and optimize their traders' profits in the derivatives market, over a dozen major banks from around the globe are involved in the LIBOR Scandal. Although the activities have been going on since at least 2003, the controversy only surfaced in 2012. In the years since the fraud was made public, banks have been fined billions of dollars, and several individuals involved have received prison sentences.

Finally

In order to help the United States move from the London Interbank Offered Rate (LIBOR) benchmark to the Secured Overnight Financing Rate (SOFR), the Alternative Reference Rates Committee (ARRC) has been collaborating with government organizations since 2014. Much of the change had already been accomplished by early 2022, as the LIBOR was largely phased out on December 31, 2021.