On August 25, the LSTA published its Term SOFR Concept Document (the “Term SOFR Concept Document”)[1]—the latest addition to its suite of SOFR-based Concept Documents.
The Term SOFR Concept Document was prepared in response to the ARRC’s formal recommendation last month of the CME’s “SOFR Term Rate” (“Term SOFR”) for use, with other forms of SOFR, in business loan activity (multi-lender facilities, middle market loans and trade finance loans) and in limited end-user-facing derivatives.[2] The Term SOFR Concept Document consists of an illustrative example of a term loan facility referencing Term SOFR as its benchmark rate of interest.
Two of the issues that need to be addressed when selecting Term SOFR are (1) applying an appropriate adjustment to account for the difference between the secured rate (SOFR) and a rate with a credit premium (LIBOR); and (2) providing a fallback mechanism to handle unavailability of the term rate. The Term SOFR Concept Document illustrates ways to handle these issues.
Spread Adjustments
The Term SOFR Concept Document offers two main alternatives to address the differential between LIBOR and SOFR arising from LIBOR’s credit component:
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Adjusted Term SOFR (with differential embedded) plus Applicable Rate: Under this approach, Term SOFR is adjusted by adding a market-determined credit spread. The Applicable Rate is the same party-specific credit spread adjustment used for LIBOR-based loans. Within this approach, the Term SOFR Concept Document offers several alternatives:
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Floors: Parties may set a floor on either Adjusted Term SOFR or on Term SOFR.
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Different Tenors: Parties may select a single spread adjustment for all tenors of Term SOFR or different spread adjustments for each tenor.
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Unadjusted Term SOFR plus Applicable Rate (with differential embedded): This approach uses unadjusted “Term SOFR”, with the market-determined credit spread embedded within the “Applicable Rate”.
Fallbacks
The Term SOFR Concept Document offers two alternative approaches for fallback language following a “Benchmark Transition Event” with respect to Term SOFR, based on the ARRC’s formulations:
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Amendment approach: Under this approach, the administrative agent and the borrower would agree on a benchmark replacement rate, giving due consideration to (a) any recommendation of the Relevant Governmental Body or (b) any evolving or then-prevailing market convention for determining a replacement benchmark for USD-denominated syndicated credit facilities.
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Hardwired approach: This approach involves two steps—first, a hardwired fallback to Daily Simple SOFR, then an amendment approach equivalent to option 1 above.
Notably, the LSTA’s definition of “Benchmark Transition Event” differs from the ARRC’s formulation in one key respect. In addition to a public announcement that Term SOFR has ceased or will cease to be published or is or will become non-representative, “Benchmark Transition Event” also includes any public announcement by CME or its regulator that all tenors of Term SOFR are not (or as of a specified future date will not be) in compliance with or aligned with the International Organization of Securities Commission (“IOSCO”) Principles for Financial Benchmarks.
While the Term SOFR Concept Document does not purport to set any standard market practice for use of the SOFR Term Rate, it is expected to facilitate market participants’ transition planning by offering alternative approaches for spread adjustments and fallback methods, as well as drafting considerations implicated by each approach.
FOOTNOTES
[1] The Term SOFR Concept Document is available to LSTA members through the LSTA website.
[2] ARRC does not support the use of Term SOFR in consumer products or the vast majority of the derivatives market.
Copyright © 2021, Sheppard Mullin Richter & Hampton LLP.National Law Review, Volume XI, Number 250
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