ARRC Publishes SOFR Spread Adjustment Similar to ISDA, Recommends One-Year Transition for Consumer Products
The Alternative Reference Rates Committee ("ARRC") recommended for consumer products a one-year transition period for the five-year median spread adjustment methodology. During the transition period, the spread adjustment that would apply to each day in the period would be a spread adjustment determined by interpolating between the static spread adjustment determined on a day before the fallback trigger event occurred and the spot spread adjustment between USD LIBOR and the relevant adjusted secured overnight financing rate ("SOFR") for such day.
According to the ARRC, the recommended spread adjustment methodologies are intended to be used in connection with USD LIBOR contracts that have incorporated the ARRC-recommended hardwired fallback language that provides for a fallback rate based on the SOFR and the applicable spread adjustment. The purpose of the spread adjustment is to reduce the economic impact of shifting from an unsecured rate to a rate that is nearly risk-free (e.g., because USD LIBOR includes bank credit risk, it is likely to be higher than a related term-adjusted SOFR).
The ARRC stated that it intends to release more detailed final recommendations for the spread adjustment methodology for cash products. The ARRC noted in its release, which summarizes the results of the Consultation, that it is committed to making sure its recommended spread adjustments and the resulting spread-adjusted rates are published, and further noted that it will work with potential vendors to make the spreads and the spread-adjusted rates publicly available.
As previously covered, the ARRC launched a consultation seeking feedback from market participants regarding the ARRC's recommended spread adjustment methodologies for cash products referencing USD LIBOR, titled "ARRC Consultation on Spread Adjustment Methodologies for Fallbacks in Cash Products Referencing USD LIBOR" (the "Consultation").
In response to feedback to the Consultation, at its April meeting, the ARRC agreed to recommend a spread adjustment methodology based on the historical median difference between USD LIBOR and the relevant adjusted SOFR calculated over a five-year lookback period. The ARRC spread adjustment recommendation will be used to determine a static spread adjustment amount in respect of each USD LIBOR tenor, meaning the spread adjustment amount will be fixed on a date occurring on or before the date of the occurrence of the related fallback trigger event. The ARRC has acknowledged that the recommended methodology will produce different spread adjustment amounts for different USD LIBOR tenors. The ARRC further acknowledges that its spread adjustment methodology is substantially similar to the methodology adopted by ISDA with respect to its LIBOR fallback initiatives.