LIBOR was discontinued for most currencies at the end of 2021, with only USD LIBOR set to be discontinued in 2023.[1] As noted earlier, LIBOR has been widely accepted as a reference by tribunals in their decisions on pre-award interest rates.[2] The question now is what will replace it as the new benchmark lending rate. The Secured Overnight Financing Rate (SOFR) has emerged as a leading benchmark in financial markets.
SOFR shares considerable similarities with LIBOR. It is based on the rates that large financial institutions pay to one another for overnight loans.[3] Because LIBOR was an unsecured rate and SOFR is secured, SOFR is associated with lower risk than LIBOR. This fact is illustrated by, for example, SOFR rates being lower than LIBOR rates in both the overnight and 12-month tenors. Figure 1 below shows LIBOR’s spread over SOFR for the 12-month tenor.[4] Since 2020, SOFR has been lower than LIBOR by an average of 26 bp (i.e., 0.26 percentage points).[5]
Figure 1: LIBOR spread to SOFR, 12M tenor[6]
Although SOFR and LIBOR are similar, it is important that tribunals not simply move the goalposts by changing pre-award interest rates such as LIBOR+2.00% to SOFR+2.26%, for example. Recall from Pre-award interest: Is LIBOR+2% a reasonable commercial rate? that true borrowing costs vary with the borrower’s risk and with market conditions. The same principles apply to SOFR.
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[1] Various forms of LIBOR across currencies, including GBP LIBOR, and tenors have already been discontinued, with the publication of USD LIBOR set to end in June 2023.
[2] Tiago Duarte-Silva and Swati Kanoria, “The importance of interest in arbitral awards,” CRA Insights, 2022.
[3] Federal Reserve Bank of NY. https://www.newyorkfed.org/markets/reference-rates/sofr.
[4] Note that SOFR is an overnight rate by definition; 12M-term SOFR is based on swaps.
[5] Median LIBOR spread over SOFR, 12M tenor, January 2020–February 2022. Data from Eikon and ICE.
[6] Data from Eikon and ICE.
