Term SOFR concept document published

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On August 25, the LSTA published its SOFR Concept Document Term (the “SOFR Concept Document Term”)[1]—The latest addition to its suite of SOFR-based concept papers.

The SOFR Term Concept Document was prepared in response to the ARRC’s formal recommendation last month regarding the CME’s “SOFR Term Rate” (“SOFR Term”) to be used, along with other forms of SOFR, in business lending activities (multi-lender facilities, medium market lending and trade finance lending) and in a limited number of derivative products intended for end users.[2] The SOFR Term Conceptual Document is an illustrative example of a term loan facility that references the SOFR Term as the benchmark interest rate.

Two of the issues that must be resolved when selecting the SOFR term are (1) applying an appropriate adjustment to account for the difference between the guaranteed rate (SOFR) and a rate with a credit premium (LIBOR) ; and (2) provide a back-up mechanism to manage the unavailability of the forward tariff. The Term SOFR Concept Document illustrates the means of dealing with these problems.

Spread adjustments

The SOFR Conceptual Term Document proposes two main alternatives for dealing with the differential between LIBOR and SOFR resulting from the credit component of LIBOR:

  1. SOFR adjusted term (with built-in differential) plus applicable rate: In this approach, the SOFR term is adjusted by adding a market determined credit spread. The applicable rate is the same party-specific credit spread adjustment used for LIBOR-based loans. In this approach, the SOFR Concept Term Document offers several alternatives:

    • Floors: The parties can set a floor either on the adjusted SOFR term or on the SOFR term.

    • Different tenors: Parties can select a single spread adjustment for all SOFR term maturities or different spread adjustments for each tenor.

  1. Not corrected SOFR term plus Applicable Rate (with integrated differential): This approach uses an unadjusted “Term SOFR”, with the market determined credit spread integrated at the “Applicable Rate”.

Fallback solutions

The SOFR Term concept document proposes two alternative approaches for the fallback language following a “reference transition event” to the SOFR term, based on the ARRC formulations:

  1. Modification approach: Under this approach, the administrative agent and the borrower would agree on a benchmark replacement rate, taking due account of (a) any recommendation from the relevant government agency or (b) any changing or prevailing market at the time to determine a replacement benchmark for USD denominated syndicated credit facilities.

  2. Wired approach: This approach involves two steps: first, a wired fallback to Daily Simple SOFR, then a modification approach equivalent to option 1 above.

Notably, the LSTA’s definition of “baseline transition event” differs from the ARRC’s wording on a key point. In addition to a public announcement that the term SOFR has ceased or will cease to be published or is or will become unrepresentative, “benchmark transition event” also includes any public announcement by CME or its regulator that all the terms of the term SOFR do not (or at a specified future date will not) conform or align with the principles of the International Organization of Securities Commissions (“IOSCO”) for financial benchmarks.

Although the SOFR Term Concept Document does not purport to define standard market practice for the use of the SOFR Forward Rate, it should facilitate transition planning for market participants by offering alternative approaches for spread adjustments and fallback methods, as well as the drafting considerations involved with each approach.

FOOTNOTES

[1] The concept paper for the term SOFR is available to LSTA members through the LSTA website.

[2] The ARRC does not support the use of the term SOFR in consumer products or the vast majority of the derivatives market.

Copyright © 2021, Sheppard Mullin Richter & Hampton LLP.Revue nationale de droit, volume XI, number 250


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