LIBOR (London Inter-Bank Offered Rate) is the average interest rate generated by a panel of 18 major global banks and represents the cost of interbank lending across a spectrum of short-term time horizons. Between 2008 and 2011, it was discovered that banks were manipulating rates, spurring regulators to initiate the sunset of LIBOR at the end of 2021 and the search for a LIBOR replacement that was liquid, transparent, representative of the market, and not easily manipulated.
To prepare for this transition, other indices will be used to benchmark interest rates as an alternative to LIBOR. The Secured Overnight Financing Rate, or SOFR, is an interest rate that banks use to price U.S. dollar-denominated derivatives and loans. The daily SOFR is based on transactions in the treasury repurchase market, where investors offer banks overnight loans backed by their bond assets. The Alternative Reference Rate Committee (ARRC) identified the SOFR as an accepted LIBOR replacement for USD-based securities.
Clearwater is dedicated to staying ahead of market changes. To adapt to this market change, Clearwater plans later this year to add accrual calculations and analytics that leverage the SOFR to facilitate a smooth transition away from the LIBOR index.
Clearwater product and development teams are developing calculation models for the various security types that leverage this index. The models include both simple and compounding accrual calculations. Simple accrual calculations are determined on the principal of the security, while compounding accrual calculations are based on the principal amount of the security as well as the accumulated interest of previous periods. The compounding accrual calculation is a new capability for Clearwater and something we are pleased to release to our users. The simple accrual calculation as well as analytics supporting yield, duration, and convexity for securities that reference SOFR have been successfully supported by Clearwater for many years.
Clearwater plans to support the following indices as LIBOR replacements in the coming months: SONIA, ESTR, TONA, and SARON.