Following up on our past posts on the transition away from the London Interbank Offering Rate (“LIBOR”), and interbank offering rates (“IBOR”) denominated in other currencies, in this post, we discuss the agreement reached by the members of the Alternative Reference Rates Committee (“ARRC”) on a spread adjustment methodology for cash products referencing U.S. dollar (USD). The agreement is part of the ARRC’s ongoing effort to help support a smooth transition from LIBOR to the Secured Overnight Financing Rate (“SOFR”).

The ARRC’s recommended methodology for market participants’ voluntary use, announced April 8, 2020, is to produce spread adjustments intended for USD LIBOR contracts that have incorporated the ARRC’s recommended hardwired fallback language, or for legacy USD LIBOR contracts where a spread-adjusted SOFR can be selected as a fallback.

The ARRC is recommending a spread adjustment methodology based on a historical median over a five-year lookback period calculating the difference between USD LIBOR and SOFR.  For consumer products, the ARRC is additionally recommending a 1-year transition period to this five-year median spread adjustment methodology. The five-year median spread adjustment methodology matches the methodology recommended by the International Swaps and Derivatives Association (ISDA) for derivatives and would make the ARRC’s recommended spread-adjusted version of SOFR comparable to USD LIBOR and consistent with ISDA’s fallbacks for derivatives markets.  See our earlier blog:  The LIBOR Transition – ISDA Consultation Market Responses.  The recommendations follow a consultation launched in January 2020 and feedback received from more than 60 market participants.

The ARRC reports that in the coming weeks it will release a more detailed final recommendation of the spread adjustment methodology for cash products. The ARRC has committed to making sure its recommended spread adjustments and the resulting spread-adjusted rates are published and will work with potential vendors to make sure that these spreads and spread-adjusted rates are made publicly available.

“The LIBOR Transition” is a periodic series of updates discussing reference interbank offering rates, such as LIBOR, and the challenges involved in navigating a successful transition from their use as reference rates of choice in the market. Norton Rose Fulbright has assembled a group of its lawyers from around the globe to stay on top of these issues and assist clients in the transition to new reference rates. More information can be found  on our Norton Rose Fulbright web site.