July 22, 2021 - by Meredith Coffey. On July 21, the ARRC released recommended conventions for forward looking Term SOFR (and SOFR Averages in Advance) for syndicated and bilateral business loans. This release coincided – not coincidentally – with the publication of Term SOFR Use Cases, which included business loans, related hedges and CLOs. The ARRC Business Loans Working Group (“BLWG”), which is co-chaired by the LSTA, developed these conventions.
Background: The ARRC’s Daily Simple SOFR and Daily Compounded SOFR in Arrears Conventions (published in July 2020) were complicated because these rates are not known in advance of the interest period and therefore many conventions differed from LIBOR conventions. In contrast, because Term SOFR is known in advance of the interest period – just like LIBOR today – the Term SOFR loan conventions are very similar to LIBOR loan conventions. In other words, new Term SOFR loans may almost be plug-and-play with LIBOR documentation and systems. Below, we focus on Term SOFR and flag where the conventions are similar to LIBOR, and where they may differ slightly. (The entire conventions document is a mere five pages, so it is an easy read for those that want more detail.)
The Term SOFR Rate: CME Term SOFR is the ARRC-recommended Term SOFR rate; it is available in 1M, 3M and 6M tenors via CME DataMine, CME’s Market Data Platform (MDP), and data redistribution partners such as Bloomberg and Refinitiv. SOFR is typically published on US business days, and CME Term SOFR aligns with that calendar. However, if SOFR is not published on a US business day, the previous day’s Term SOFR rate may be used up to three days. The ARRC recommended that interest rate floors on new Term SOFR loans apply to SOFR itself (as opposed to SOFR plus the ARRC spread adjustment).
Timing Conventions: Like LIBOR, Term SOFR is recommended to have a two-day lookback (e.g., the rate published two days before the start of the interest period would be selected and locked for the entirety of the interest period) and borrowers are recommended to provide a notice of borrowing three days prior to the borrowing date. The recommended day count convention is similar to USD LIBOR (Actual/360), but it is possible to use other day count fractions (e.g., Actual/365). Similarly, the recommendation is to use “Modified Following Business Day” conventions for Term SOFR, just like LIBOR.
Existing LIBOR Loans that fall back to Term SOFR: For existing LIBOR loans that fall back from LIBOR to SOFR, there are just a few additional conventions. First, if these loans use hardwired fallbacks, they will apply an ARRC spread adjustment to minimize the difference between LIBOR (a generally higher, unsecured rate) and SOFR (a generally lower, secured rate). These spread adjustments were fixed on March 5, 2021 at 11 bps for 1M contracts and 26 bps for 3M contracts. Second, if the loan had a LIBOR floor, the floor would be measured against SOFR plus the ARRC spread adjustment.
And that’s (mostly) it for the Term SOFR conventions! Because the Term SOFR is known in advance of the interest period, it is largely documented and operationalized like LIBOR. At least one thing in LIBOR transition may be easy(ish)!