On January 21, 2020, the Alternative Reference Rates Committee (ARRC) of the Federal Reserve Board and the Federal Reserve Bank of New York released a consultation seeking comments from market participants on the spread adjustment methodology it intends to recommend as part of its fallback provision recommendations for cash products referencing the London Interbank Offered Rate (LIBOR). Responses must be submitted by March 6, 2020.
As discussed in the consultation, ARRC previously published recommended fallback language for market participants to consider for cash products referencing LIBOR, including floating rate notes (FRNs), syndicated and bilateral business loans (Business Loans), securitizations, and residential closed-end adjustable rate mortgages (ARMs). The fallback language for these cash products defines the trigger events (e.g., the indefinite cessation of LIBOR) that precipitate the replacement of LIBOR with a benchmark based on the Secured Overnight Financing Rate (SOFR), which is ARRC’s recommended alternative benchmark, and a recommended spread adjustment, or in the case of ARMs, a published replacement index that would already incorporate the recommended spread adjustment. Note that ARRC is contemplating publishing such replacement index for ARMs and other major consumer products.
For FRNs, Business Loans, and securitizations, the consultation provides that ARRC intends to recommend a spread adjustment methodology that would make the SOFR spread-adjusted rate comparable to LIBOR. The methodology would establish a static spread adjustment that is fixed on or prior to the date of the occurrence of a trigger event. The methodology, however, would be applied separately to calculate the recommended spread adjustments across the different LIBOR tenors (i.e., one-month, two-month, three-month, six-month, and one-year LIBOR), resulting in spread adjustments that may differ for each tenor. The recommended spread adjustments would be intended for use in LIBOR contracts that have incorporated ARRC’s recommended fallback language, or for legacy LIBOR contracts in which the parties can and do select an ARRC recommended spread-adjusted rate as a fallback, and would not be intended to apply to new contracts referencing SOFR.