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Alerts and Updates

ARRC Announces Likely Administrator of Forward-Looking SOFR Term Rate

May 28, 2021

ARRC Announces Likely Administrator of Forward-Looking SOFR Term Rate

May 28, 2021

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This is the latest in a series of up and down indications from the ARRC as to when a Term SOFR rate may be available.

It’s been a few weeks since our May 10 Alert highlighting the major developments that have happened so far this year in LIBOR transition. The developments lead to some tantalizing possibilities as to what will happen next. As we head into the Memorial Day weekend, we thought we would highlight one of the more significant announcements since that Alert came out.

One month after CME Group announced the launch of its Term SOFR Reference Rates, the Alternative Reference Rates Committee (ARRC) announced May 21, 2021, that it plans to recommend CME Group as the administrator of a forward-looking Secured Overnight Financing Rate (SOFR) term rate “once market indicators for the term rate are met” (emphasis in the ARRC announcement).

This is the latest in a series of up and down indications from the ARRC as to when a Term SOFR rate may be available. First it was anticipated before the end of 2020, then it was the “first half of 2021.” On March 23, 2021, the ARRC appeared to switch course and announced that it will not be in a position to recommend a Term SOFR rate by mid-2021 since the trading in SOFR derivatives that is necessary to establish the rate is still very light. In a foreboding sign, the ARRC encouraged market participants not to wait for Term SOFR.

Since then, it appears that the ARRC has backtracked a bit. In April, the ARRC announced three key principles that it will consider in recommending a Term SOFR rate. Earlier in May, it followed up with some of the market indicators that would allow it to consider recommending a Term SOFR rate “relatively soon.”

In that context, one could be excused for misreading the first two lines of the May 21 announcement and feeling a certain exuberance that Term SOFR is here now. To be clear, the ARRC ended the sentence with the boldfaced phrase above. Still, the next paragraph contains a few quotes from ARRC Chair Tom Wipf that “a recommended term rate is now in clear sight,” and “[the] announcement should allow market participants to plan ahead for the recommendation of CME Group as the term rate administrator soon.”

It’s anyone’s guess as to how “in clear sight” and “soon” will translate into actual timing, but it is a progressive step toward market use of Term SOFR. The “plan ahead” portion of Wipf’s quote remains the tricky part for market participants to resolve. Based on the March statement, some lenders that otherwise might have preferred Term SOFR may have resolved to move forward with simple SOFR. This latest statement could cause them to reconsider the issue and delay their implementation. Lenders that planned to start SOFR originations by midyear in compliance with regulator guidance might wait a few months to see how the market develops so as not to be out of step.

For other lenders, the availability of Term SOFR might not change their plans yet. The ARRC’s key principles and market indicators are not just items on a list to check off, but fundamental aspects of a workable Term SOFR. There may be enough SOFR derivatives activity to get a Term SOFR rate off the ground, but it may not be enough to support a complete market switch to Term SOFR right away. In that regard, it will be interesting to see if the ARRC tempers its key principle that Term SOFR should have a "limited scope of use." Hopefully this will just be a chicken and egg problem as market adoption of SOFR takes off.

Transition of legacy LIBOR loans is on the backburner while the market focuses on the coming deadline to cease new LIBOR originations at the end of this year. Nonetheless, this announcement is eventful news for legacy loans. With the market-agreed spread adjustment, term SOFR is a relatively seamless transition away from LIBOR. Knowing in advance that Term SOFR will be available allows lenders to “plan ahead” for a smoother transition for legacy contracts, with or without ARRC recommended hardwired language.

So far, much of the planning for SOFR has focused on lenders, but borrowers are also “market participants” and need and want to get in on the act as well. On April 27, 2021, leaders of the Association for Financial Professionals, the National Association of Corporate Treasurers and the U.S. Chamber of Commerce joined in a letter to U.S. Treasury Secretary Janet Yellen, Federal Reserve Board Chair Jerome Powell, New York Fed President John Williams, Securities and Exchange Commission Chair Gary Gensler and acting CFTC Chair Rostin Behnam.

One of the main points raised by the letter is that many nonfinancial corporate borrowers “currently struggle in obtaining from their lenders specific proposals and processes for how their loan agreements will be amended and the mechanics of how the ARRC’s recommended SOFR rate will substitute for LIBOR” and that “they are unable to negotiate current access to SOFR borrowings, even with large multi-year credit agreements nearing renewal.” As is evident from the letter and the attached survey charts, borrowers have a particular interest in seeing the stable SOFR rate prevail as the replacement for LIBOR over “credit-sensitive rates” that can “spike up, causing a spiral of increasing unreliability” during periods of “financial market stress.” Lenders may have a different view on that subject. Ultimately, both groups need to find a solution.

Last week’s announcement by the ARRC moves things in the right direction, but much work remains. To be continued after the Memorial Day holiday…

About Duane Morris

Duane Morris attorneys assist lenders in formulating their documentation and strategy for post-LIBOR loans and applying amendments that address the interest rate changes in legacy loans through general, descriptive measures. As the end of LIBOR draws closer, Duane Morris’ LIBOR Transition Team will continue to monitor developments and issue additional Alerts. Stay tuned to the LIBOR Transition Team webpage and blog for updates.

For More Information

If you have any questions about this Alert, please contact Roger S. Chari, Joel N. Ephross, Amelia (Amy) H. Huskins, Phuong (Michelle) Ngo, Han Wang, any of the attorneys in our Banking and Finance Industry Group or the attorney in the firm with whom you are regularly in contact.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.