June 15, 2020 - The ARRC Best Practices Recommendations for LIBOR Transition came out several weeks ago and, critically, Business Loans Best Practice Recommendation # 1 is that new business loans should include hardwired fallback language no later than September 30, 2020.
ARRC hardwired fallback language for syndicated loans was first published in April 2019. However, to make the transition easier, the ARRC will be releasing refreshed hardwired loan fallback language this month. There are two important points: First, the structure of the fallback language should remain consistent. Second, since April 2019, we have learned a great deal about how SOFR could be implemented in the loan market. These lessons should inform some of the refinements to the fallback language. We discuss both below.
The structure of fallback language is likely to remain the same as the April 2019 version. Specifically, there are three components of hardwired fallback language: 1) The trigger that starts the transition, 2) the selection of the replacement rate, and 3) any spread adjustment used to minimize economic transfer during the switch from LIBOR to the replacement rate. Market participants should see that – in both the old and new hardwired fallback language – the triggers remain LIBOR cessation or the announcement that LIBOR is no longer representative. Second, SOFR remains the hardwired replacement rate. Third, the spread adjustment remains either an adjustment endorsed by the ARRC or, if that doesn’t exist, the adjustment used by ISDA. Finally, the failsafe in both approaches should still be the amendment approach. Thus, if market participants want to prepare for hardwired fallbacks in the coming weeks, they can think about how they would implement the “waterfall” process identified in the 2019 fallback language.
While the architecture is likely to remain the same, we have learned a lot about the applicability of SOFR to the syndicated loan market. For instance, we have learned that Simple Daily SOFR is much easier to operationalize than SOFR Compounded in Arrears for an instrument that permits intraperiod prepayments and trades without accrued interest. For this reason, different types of SOFR might be identified at points along the hardwired replacement rate waterfall.
The refreshed hardwired fallback language should be released within the month. But with the September 30, 2020 deadline looming, we wanted to provide tools for market participants to begin to prepare.