(Reuters) – A financial industry group backed by the Federal Reserve and other U.S. government agencies released on Thursday a proposal on how the mortgage industry would adopt the usage of the Secured Overnight Financing Rate (SOFR) in lending to consumers.
Regulators have urged the financial industry to move away from the London interbank offered rate (LIBOR) as a benchmark, which is expected to be phased out after 2021 in the aftermath of a rigging scandal.
LIBOR is a rate reference for $200 trillion of U.S. financial products, primarily in interest rate derivatives. There are roughly $1 trillion in adjustable-rate mortgages, or about 6.5% of all U.S. home loans outstanding, which are reset against it.
The Alternative Reference Rates Committee’s (ARRC) consumer products working group developed this “white paper” on the adaption of SOFR by the mortgage market. Other ARRC groups have released frameworks for SOFR in derivatives and business loans.
“The paper shows that there are ways to avoid subjecting consumers to the risks inherent in LIBOR,” said Tom Wipf, ARRC chair and vice chairman of institutional securities at Morgan Stanley in a statement. “It is possible to use SOFR now to develop products that are built on a robust reference rate that is firmly grounded in market transactions.”
With this roadmap on SOFR, committee members hope the mortgage industry including Fannie Mae (FNMA.PK) and Freddie Mac (FMCC.PK) – which are also ARRC members – would develop products for consumers and investors linked to SOFR.
But adoption of SOFR has been slow. A factor that has hindered its acceptance is the lack of a term market right now, in which participants could reference loans and other products as far out as 30 years, analysts said.
The “white paper” showed 30-day or 90-day indexes that average daily SOFR figures as alternatives to one-year LIBOR as reference for adjustable-rate mortgages.
The New York Federal Reserve has indicated it plans to begin publishing SOFR indexes in the first half of 2020.
The ARRC proposal suggested SOFR-based mortgages would be reset every six months as opposed to every year on current LIBOR-linked loans.
It also proposed the rate cap on SOFR adjustable mortgages would be 1% per reset period compared with a 2% annual cap on LIBOR loans.
The white paper discusses new loans linked to SOFR, not existing loans that may switch over to SOFR from LIBOR.
ARRC said it plans to issue on Friday a consultation on fallback, or contingency, contract language for consumer mortgages.
(GRAPHIC-Dollar LIBOR market footprint:tmsnrt.rs/2HQMkq6)
Reporting by Richard Leong, editing by G Crosse