December 16, 2020 - On Tuesday, the LSTA’s Primary Market Committee received a revised draft of the Daily Compounded SOFR (Compound the Rate) Concept Document.
Summary of Revisions to the February Draft
Daily Compounded SOFR
After considered discussion among market participants and systems providers, it is clear that syndicated loan facilities will need to accrue interest on a daily basis. The concept credit agreement provides for a daily SOFR loan, i.e. interest accrues on a daily compound basis for each day of the interest period, with a lookback (of a number of days for parties to determine). As a daily rate loan, interest accrues on a real-time basis (i.e. “in arrears”) so the amount of interest owed by the borrower would not be known until the end of the period without the use of a convention that permits certainty as to the interest amount before the interest payment is due. In accordance with the ARRC’s Recommended Conventions for Syndicated Loans, the concept document includes a lookback with no observation shift to accomplish this. A lookback simply shifts backwards the period of time that the rates are observed.
The concept document includes the calculation formula for compounding using the “non-cumulative compounded rate” (NCCR) approach. This formula is set forth in new Schedule 1.01. The NCCR is a daily calculation based on, but different from, the formula set forth in ISDA’s “SOFR” definition. The NCCR method applies a calculated compounded interest factor based on the difference between the “Cumulative Compounded Effective Rate” for that given day and the prior day to arrive at a daily compounded accrual. Use of this method requires intra-period prepayments of principal (or conversions) to be accompanied by the repayment of accrued interest on the prepaid amount as set forth in Section 2.06(e) and separate calculations of portions of SOFR Loans prepaid in order to account for changing principal over time. It also assumes no paydowns may be made on non-U.S. Government Securities Business Days. Use of the NCCR method is necessary to accrue interest on a compounded basis if it is expected that the loan facility will be traded or if any of the parties to the transaction need to accrue interest on a daily basis. For more information on the NCCR method generally, please refer to the ARRC Recommended Conventions for Syndicated Business Loans and the accompanying Technical Appendices.
The concept document also includes, for illustrative purposes only, the calculation formula for compounding using the “cumulative compounded rate” (CCR) method. The CCR method is based on the compounded average formula set forth in ISDA’s “SOFR” definition. Use of this method may be appropriate if the loan facility will not be traded and none of the parties to the transaction need to accrue interest on a daily basis. For more information on the CCR method, please refer to the ARRC Recommended Conventions for Syndicated Business Loans and the accompanying Technical Appendices.
Updated fallback language
The revised draft of the concept document includes updates to the amendment approach fallback language (for falling back from Daily Compounded SOFR) based on the ARRC’s updated fallback language released in June 2020, where appropriate.
Carryover revisions from Daily Simple SOFR concept document
The revised draft includes conforming changes based on the Daily Simple SOFR concept document, where appropriate. One of these changes is to include Term SOFR “flip forward” language which would hardwire a future transition to Term SOFR if one were to be available and recommended by the ARRC. The sample language providing for the “flip forward” has been included in brackets and highlighted in blue (as it is in the Daily Simple SOFR concept document).
Here are blacklines against the February draft, against the Daily Simple SOFR Concept Document and against the LSTA’s IG Term Loan Form.
Next Steps
This document provides an illustrative example of Daily Compounded SOFR as it is currently anticipated to be implemented in the U.S. loan market. Members should bear in mind that the concept document does not purport to represent or set any standard market practice. It has been developed simply as a tool to further familiarize market participants with replacement benchmark alternatives, in this case Daily Compounded SOFR (Compound the Rate), which will hopefully further assist each institution with its own transition planning. The final concept document will be published in 1Q21.
For further information, please contact Tess Virmani.
