Today is the day that the New York Fed’s Alternative Reference Rates Committee (ARRC) recommended transition to a “hardwired” approach for LIBOR[i] successor provisions in U.S. dollar-denominated syndicated credit facilities takes effect. Henceforth, to the extent not already utilized, all new syndicated business loans should include ARRC-recommended (or substantially similar) hardwired USD LIBOR fallback language. No later than October 31, 2020, all new bilateral business loans should include ARRC-recommended (or substantially similar) hardwired or hedged USD LIBOR fallback language.
The hardwired fallback language recommends simple daily SOFR in arrears in the second step of the waterfall along with a more flexible early opt-in trigger that permits the parties to the loan to shift to an alternative rate such as SOFR ahead of LIBOR’s discontinuance or otherwise determined not to be representative.
What is SOFR? As a reminder, since April 2018, SOFR is the secured overnight financing rate for transactions in the Treasury repo market available on the New York Fed’s website. SOFR is a secured, overnight rate, that updates daily. SOFR indexes to a significant volume of approximately $1 trillion worth of U.S. dollar transactions in the repo market. LIBOR is an unsecured term rate that can be quoted in one-month, three-month, six-month or other manners that indexes approximately $500 million in daily London interbank loans that is easy to determine. SOFR is rather intricate to determine and the means to compute and apply it are still developing for application for various instruments and transactions (with at least four alternatives of SOFR currently in development).
What is the Hardwired Approach? In simple terms, parties to a loan agree to:
- the triggers that will cause LIBOR to be replaced by a successor rate;
- the waterfall-like sequence of steps through which a successor rate will be selected;
- a spread adjustment waterfall so the lenders’ margin remains consistent causing SOFR or other substitute paradigm more comparable to LIBOR; and
- permission to prepare corresponding adjustments in order for the rate to perform as intended.
Please see Part II of this IM Blog post, with a discussion of these foregoing four items, in the coming week as well as additional developments.[i] London Interbank Offered Rate (LIBOR), which has served as a reference rate for approximately $350 trillion of debt and derivatives, will be phased out after December 31, 2021,