August 9, 2021 - by Tess Virmani. As you know, the Alternative Reference Rates Committee (ARRC) has recommended CME Group’s forward looking Secured Overnight Financing Rate (SOFR) term rates (SOFR Term Rates) for use in ARRC recommended fallback language as well as syndicated and bilateral business loans, CLOs, and end-user facing hedges on Term SOFR-referenced assets. See the ARRC’s Recommended Term SOFR Use Cases. In light of the ARRC’s recommendation, the LSTA has prepared a draft Term SOFR Concept Document to augment its suite of SOFR-based Concept Documents. This document illustrates a term loan facility referencing Term SOFR as its benchmark rate of interest and a high-level summary of the document is set forth below.
Overview
First, in putting together the draft, the LSTA sought to reflect the conventions that the ARRC recently published however we have also included some additional convention options on which the ARRC conventions are silent. The reason for this is that we have endeavored to provide different permutations and points of consideration to assist members as they work through their own implementation of Term SOFR. Second, the draft contains a fair amount of optionality numerous footnotes which contain explanatory notes and, in some cases, member questions. These footnotes should be read as an integral part of the draft.
Points of Focus
Benchmark Structure and Floors
As you know, LIBOR and SOFR are inherently different in that SOFR is a secured rate while LIBOR includes a credit premium. Where the differential is being addressed in ARRC hardwired fallback language by applying the ARRC/ISDA spread adjustment to Term SOFR, there are several ways in which the differential can be addressed in new loan origination. We have offered drafting for those alternative approaches:
- Term SOFR plus Applicable Rate (with differential embedded); Term SOFR is floored, or
- Adjusted Term SOFR (with differential embedded) plus Applicable Rate:
- Adjusted Term SOFR is floored or Term SOFR is floored
- A single spread adjustment for all tenors or different spread adjustments for each tenor of Term SOFR.
The concept document has included flag posts in the footnotes for the drafting considerations implicated by each approach.
Fallback Language
If this experience has taught us anything it is the importance of robust fallback language! There are two alternative approaches based on ARRC recommended fallback language set out in the concept document for consideration:
- An amendment approach, or
- A hardwired fallback to Daily Simple SOFR and then an amendment approach as the second and final step.
Member feedback is requested on whether an additional fallback language trigger tied to Term SOFR no longer being IOSCO compliant would be appropriate to include.
Health Warning!
Members must bear in mind that this 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 Term SOFR, which will hopefully further assist each institution with its own transition planning.
To assist in your review a blackline against our LIBOR referenced term loan form is available here. A blackline against our Daily Simple SOFR Concept Document is available here. A zoomcast explaining the concept document is available here. Please contact tvirmani@lsta.org with any questions.
