News

Update: ARRC Releases Term SOFR FAQs

August 27, 2021

On August 27, the Alternative Reference Rates Committee (ARRC) released frequently asked questions (FAQs) on best practice recommendations related to scope of use of SOFR term rates. As noted in an August 26 CREFC Alert, the markets and the regulatory community continue to prepare for the upcoming LIBOR cessation. The ability to utilize term SOFR rates is an issue important to CREFC members -- both balance-sheet and securitized lenders and servicers alike. 
  
The FAQs specifically and importantly address why limits to term rate scope of use are important, stating:

The rate should…have a limited scope of use, to avoid: 

1.     Use that is not in proportion to the depth and transactions in the underlying derivatives market;
or
2. Use that materially detracts from volumes in the underlying SOFR-linked derivatives transactions that are relied upon to construct a term rate, making the term rate itself unstable over time.

The ARRC’s recommendations related to scope of use of the SOFR term rate are intended to promote that objective.

In advance of its formal SOFR term rate recommendation, announced on July 29, the ARRC released recommended best practices for using SOFR term rates. 

Term Rate for Commercial Real Estate Loans and Securities They Collateralize.

The ARRC supports the use of SOFR term rates in areas where use of overnight and averages of SOFR has proven to be difficult. Specifically, the ARRC recognizes commercial real estate (CRE) loans as falling under the larger business loans category, which allows for the use of SOFR term rates in commercial mortgages and in turn the securitizations these loans collateralize. Please see the August 4 CREFC Alert for more detail.
  
The FAQs also address the use of SOFR term rate derivatives for end-user facing derivatives, defining such end-users as “a direct party or guarantor to a new SOFR term rate business loan or securitization-linked to SOFR term rate assets, or to a legacy LIBOR product that has converted to the SOFR term rate through contractual fallback language or legislation.”
  
Finally, the ARRC states that while the SOFR term rate is the first step of the waterfall in the ARRC’s recommended hardwired fallback language for business loans, FRNs, and securitizations, the ARRC believes it is appropriate “to use a daily SOFR rate as a bilaterally-negotiated fallback where counterparties see this as feasible, have hedging requirements, and wish to better align with ISDA fallbacks and current SOFR swap market conventions.”