In a Bloomberg op-ed on Friday, Tom Wipf—chairman of the Federal Reserve’s Alternative Reference Rates Committee and vice chairman of international securities at Morgan Stanley—pushed back against several common misconceptions about the Secured Overnight Financing Rate, the ARRC’s preferred replacement for the London Interbank Offered Rate. Wipf noted that many of these misconceptions “fundamentally misunderstand how SOFR is truly used in financial contracts” and “vastly oversimplify what SOFR’s variability represents.”
“Repo market prices respond to changes in supply and demand. SOFR, which is based on actual transactions, reflects variability in actual market pricing,” Wipf wrote. “Unlike Libor, which has become increasingly based on estimates, SOFR accurately measures the market it was created to represent. This is a critical reason the ARRC selected it as its recommended alternative.”
Wipf added that because SOFR is averaged when used in financial instruments, it is ultimately less volatile than Libor. As institutions begin to transition contracts away from Libor, the ARRC has provided fallback language for a number of financial instruments, including bilateral business loans, syndicated loans and securitizations.
