On January 21, 2020, the Alternative Reference Rates Committee ("ARRC") of the Federal Reserve Board launched a consultation seeking feedback from market participants on ARRC's recommended spread adjustment methodologies for cash products referencing USD LIBOR. The consultation was titled "ARRC Consultation on Spread-Adjustment Methodologies for Fallbacks in Cash Products Referencing USD LIBOR" (the "Consultation").
The ARRC-recommended spread adjustment methodologies for the cash products are intended to be used in connection with USD LIBOR contracts that have incorporated previous ARRC-recommended hardwired fallback language that provides for a fallback rate based on the secured overnight financing rate ("SOFR") and the applicable spread adjustment. The purpose of the spread adjustment is to reduce the economic impact of shifting from an unsecured rate to a rate that is nearly risk-free (e.g., because LIBOR includes bank credit risk, it is likely to be higher than a related term-adjusted SOFR).
In the consultation, the ARRC discusses the benefits of various methodologies for determining the spread adjustment. The ARRC notes that the methodology used to determine the spread adjustment for consumer products may differ from the methodologies used for other cash products, given the different expectations in the relevant cash product markets. Following the completion of the consultation process, the ARRC intends to recommend a methodology (or methodologies) for determining the spread adjustment to the SOFR-based fallbacks. The ARRC acknowledges that the recommended methodology (or methodologies) will produce different spread adjustment amounts for different LIBOR tenors. The ARRC spread adjustment recommendation will be used to determine a static spread adjustment amount in respect of each tenor, meaning that the spread adjustment amount will be fixed on a date occurring on or before the date of the occurrence of the related fallback trigger event.
In connection with its request for feedback from market participants, the ARRC also made a request that market participants consider the following in particular:
- whether the ARRC should recommend a methodology similar to the methodology proposed by ISDA; i.e., a spread adjustment based on the median spot spread between LIBOR for each tenor and the applicable term-adjusted SOFR rate determined over a five-year lookback period;
- what methodologies the ARRC should recommend in lieu of the ISDA methodology;
- the appropriate lookback period for term-adjusted SOFR rates that lack historical data; and
- whether the ARRC should recommend a transition period.
Market participants must submit responses regarding the Consultation to the ARRC no later than March 6, 2020.
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