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Term SOFR endorsed by the ARRC

Date:
October 6, 2021

Summary

The ARRC formally recommended the CME Group's Term SOFR to support the transition away from LIBOR and as the replacement rate for contracts that use the ARRC's recommended LIBOR replacement language.

Key takeaways

  • The ARRC states that Term SOFR derivatives should be limited to end-users hedging cash products
  • The ARRC clarified that their Term SOFR scope of use includes any party to an underlying cash product, including financial institutions that are not registered swap dealers
  • Term SOFR will be the replacement rate for USD LIBOR in contracts that use the ARRC's recommended LIBOR replacement language

On July 29, the Alternative Reference Rates Committee (ARRC) formally recommended the CME Group’s forward-looking SOFR term rates (Term SOFR) to further support the transition away from LIBOR. In the accompanying best practices, the ARRC stated that, pursuant to the Financial Stability Board mandate to increase robustness in the risk-free market, the use of Term SOFR derivatives should be limited to end-users hedging cash products. Following requests from end users for clarification, including by Chatham, the ARRC subsequently revised its scope of use to clarify that an end user includes any party to the underlying cash product, such as a borrower, lender or guarantor. These parties may enter into Term SOFR swaps, caps, swaptions, or other derivatives to hedge cash product exposure or a portfolio of exposures, and financial institutions that are not provisionally registered swap dealers with the CFTC are able to offset such exposures with an upstream dealer.

For end users that have incorporated the ARRC’s recommended LIBOR replacement language for business loans, syndicated loans, floating rate notes and securitizations, this endorsement means that, unless the end user has modified the recommended replacement rate waterfall, Term SOFR, as the first priority replacement will be the replacement rate selected in the cash products that have incorporated this language. Moreover, it appears likely that Term SOFR will be the statutory replacement rate for USD LIBOR for cash products that lack effective fallback provisions for purposes of the New York State law on USD LIBOR discontinuance. We recommend that end users review the fallback language included in their cash products to confirm whether Term SOFR is within their existing replacement waterfall.

Need help with your LIBOR transition?

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About the author

  • Christopher Bender

    Director
    Regulatory Advisory

    Private Equity | Kennett Square, PA

    Chris is a Director of Regulatory Advisory where he serves Chatham’s private equity, infrastructure, and real estate clients. He brings significant experience advising on global derivatives regulatory regimes and compliance with derivatives regulation.

Disclaimers

Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.

Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.

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