On May 6, the Alternative Reference Rates Committee (the "ARRC") published a statement and a sample termsheet on how to use the new SOFR Index with floating rate notes. 3
The SOFR Index is an alternative to the calculation methods in three previously published ARRC sample termsheets for SOFR floating rate notes.4 Under the previous methods, essentially, SOFR (the secured overnight financing rate) was measured each day in the interest period, compounded, and the interest rate for the period was calculated.
The SOFR Index measures SOFR, compounded since April 2, 2018, the first date of publication of SOFR. For a SOFR floating rate note with a base rate of the SOFR Index, the interest rate would be calculated by comparing the SOFR Index levels at the start and end dates of the interest period. The interest period can be of any length. The compounding is reflected in the index level. Just like a structured note linked to the performance of the SPX measured at two points, the result could be a negative or zero interest rate. Consequently, issuers should build in an interest rate floor of zero.
The sample termsheet uses a "shifted observation period," wherein the period when interest is measured is a certain number of U.S. Government Securities Business Days prior to the first day of the interest period, and the same number of days prior to the interest payment date.
On the same day, the ARRC released a supplemental consultation on its spread adjustment methodology. 5 The supplemental consultation summarizes feedback received by the ARRC on its original consultation of January 2020, and seeks further input on certain technical details of the spread adjustment. The spread adjustment is designed to be used in the ARRC-recommended fallback provisions for U.S. dollar LIBOR floating rate notes.
These fallback provisions provide that the U.S. dollar LIBOR rate will fall back to SOFR upon a LIBOR cessation. The spread adjustment is designed to minimize value transfer between the U.S. dollar LIBOR rate and SOFR, which are inherently different rates.
3 The ARRC's statement on the use of the SOFR Index is available at: https://nyfed.org/2M0VnnV.
4 We previously discussed the ARRC's three earlier termsheets at: https://bit.ly/2XwcenQ.
5 The supplemental consultation is available at: https://nyfed.org/2ZJw7KH.
Originally published May 28, 2020.
Originally published in REVERSEinquiries: Volume 3, Issue
Click here to read the articles in this latest edition.
Visit us at mayerbrown.com
Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.
© Copyright 2020. The Mayer Brown Practices. All rights reserved.
This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.