March 6, 2020 - On March 6th, the LSTA distributed a draft of the LSTA’s Simple SOFR in Arrears concept credit agreement to the Primary Market Committee and SOFR Working Group and comments are kindly requested by COB Friday, April 17, 2020. In putting together feedback, we encourage members to include views from the business, legal and operations functions.
To assist in review, here is a blackline of the draft against the LSTA’s form of (LIBOR-referencing) IG Term Loan and here is a blackline against the current draft of the Compounded SOFR in Arrears Concept Document. In addition, a high-level summary of the document is set forth below. As a general note, we have aligned this draft, where applicable, to the draft Compounded SOFR concept document and it is our intention that the two documents be aligned where possible when published in final form.
1. Methodology and conventions
“Simple SOFR in Arrears” is determined by taking a simple average of daily SOFRs for the duration of the interest period. For a 30-day SOFR loan beginning April 1st, SOFR would be pulled and accrued (but not compounded) every day from April 1-30th. In the absence of a publicly available source, a formula for calculating simple SOFR has been included. It is the formula found in the ARRC’s User’s Guide to SOFR.
With an in arrears rate, the use of a convention is needed in order to determine the amount of interest due before the interest payment date. In this concept document, we have used a lookback. When using a lookback, the period over which SOFR is observed is “backward-shifted” for a specified number of business days. In the example above, if April 1st were a Wednesday, a two-business day lookback would mean that the period over which SOFR is observed would start on Monday, March 30th and end on Tuesday, April 28th. Use of this convention would enable parties to know the accrued interest amount two business days before the interest payment date, April 30th.
2. SOFR floors
For operational reasons, this concept document provides for a floor in the definition of “SOFR” (i.e., the daily rate that is used in calculating the simple average of SOFRs) rather than in the definition of “Simple SOFR” itself. This proposal is informed by conversations in the ARRC Operations WG and is identical to the treatment of SOFR floors in the Compounded SOFR concept document.
3. Definition of “Interest Period”
We have retained the concept of “Interest Period”, however, its use is not technically necessary in a credit agreement referencing Simple SOFR in Arrears. Assuming that there is no requirement for prepayment of principal upon a prepayment of interest, the concept would be unnecessary. Nevertheless, we have retained the concept because it preserves some of the borrowing optionality to which borrowers are accustomed and would be relevant in the context of breakage indemnities as currently drafted. We have flagged this fact in footnote 22.
4. Definition of “ABR”
The definition of “ABR” includes a SOFR prong based on the calculation of “Simple SOFR” used elsewhere in the document. As footnote 3 indicates, the SOFR prong could be based on 30-day Average SOFR published by the FRBNY. This would be aligned with the definition in the Compounded SOFR concept document, but would not be using a Simple SOFR value in the prong. Given how close Compounded SOFR and Simple SOFR are economically (please refer to LSTA’s “SOFR: Addressing Basis Biases”), parties are asked to consider whether use of a published rate would be simpler and preferable.
5. Temporary unavailability of SOFR
We have addressed the situation in which SOFR is temporarily unavailable by including a provision whereby the last available print of SOFR is used for a specified number of days. We have left it to the parties to select the appropriate number of days and note that parties should consider syncing the number of days to the number chosen for the length of the lookback (in the definition of “Simple SOFR”), the timing requests for Borrowing Requests (in Section 2.03(a)), and prepayment notices (in Section 2.06(c)) to mitigate arbitrage opportunities. After the last print window expires, the loan would begin accruing interest at ABR. It is important to note that this scenario is one in which none of the Benchmark Transition Events have occurred and so the fallback language would not be implicated. We would look to include this feature in the Compounded SOFR concept document as well.
6. Break Funding
We have included a bracketed provision designed to allow for lenders to recoup losses in the event of an intra-period prepayment. As noted initially, customary LIBOR break funding provisions do not neatly translate in the context of a daily rate, however, discussions around lenders’ cost of funding and breakage indemnities remain an open discussion point in the market. The provision is modeled on a provision that is sometimes seen in LIBOR-referencing credit agreements today and incorporates the relevant portion of language from existing LSTA forms.
With respect to other matchfunding provisions, like market disruption, the concept credit agreement’s provision covers the situation where Simple SOFR cannot be determined, but not the situation where Simple SOFR is determined to not adequately reflect lenders’ cost of funds.
7. Transition to term SOFR
Members indicated a desire to transition to Term SOFR if one were to exist and be available for use in syndicated loans. We have included bracketed language to provide for that transition. We encourage you to pay specific attention to footnotes 6 and 34 as well as the definitions of “Term SOFR” and “Term SOFR Transition Event”. We welcome specific feedback on whether and how this ability should be included, including whether the transition to Term SOFR should instead be an opt-in process (and effected through a streamlined amendment process).
8. Notice periods
We have left notice periods blank for drafters to complete, however, we note that parties may consider syncing the length of the lookback to the timing requests for Borrowing Requests (in Section 2.03(a)), prepayment notices (in Section 2.06(c)) and the last print SOFR window (in the definition of “SOFR”) to mitigate arbitrage opportunities.
9. SOFR fallback language
If this exercise has taught us anything, it is that nothing is certain. Therefore, the concept document includes robust fallback language if “Simple SOFR” would no longer be available as a reference benchmark. In drafting this fallback language, we have modified the ARRC’s recommended “amendment approach” fallback language to apply its streamlined amendment process to a future transition away from SOFR.
Members are encouraged to keep 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 Simple SOFR in Arrears, which will hopefully further assist each institution with its own transition planning.
For more information, please contact Tess Virmani.