The proposed methodology is based on historical data and aligned with ISDA’s recommendation.

On April 8th, 2020, the Alternative Reference Rates Committee (ARRC) agreed on a recommendation for spread adjustment methodology for cash products referencing U.S. Dollar (USD) LIBOR.1 The ARRC made this recommendation after conducting a public consultation, during which more than 60 responses were received from participants across the financial services industry, including consumer advocacy groups, asset managers, corporates, banks, industry groups and government entities, among others.2

What this means

The spread adjustment methodology the ARRC is recommending is based on a historical median over a five- year lookback period calculating the difference between USD LIBOR and the Secured Overnight Financing Rate (SOFR).3 This spread adjustment methodology is aligned with the recommendation from the International Swaps and Derivatives Association (ISDA) for derivatives and would make the spread adjusted version of SOFR equivalent to USD LIBOR, and compatible with ISDA’s fallbacks for derivatives markets.4

Furthermore, the ARRC is recommending a one-year transition period to this methodology for consumer products, which was supported by many respondents to the public comments, including consumer advocacy groups.5

Conclusion

The ARRC’s recommended methodology is for market participants’ voluntary use, however Tom Wipf, ARRC chair, stated, “This announcement of a recommended spread adjustment methodology provides important clarity that should encourage those who have not already done so to begin using the ARRC’s fallback language,”6 and “The ARRC believes that the use of hardwired language that clearly sets out the replacement for LIBOR is best practice and I urge everyone to use ARRC’s recommended fallback language in their contracts now.”7

In the near future the ARRC is expected to release a final recommendation concerning the spread adjustment methodology for cash products and has committed to making sure these spreads and spread adjusted rates are made publicly available.8

References 

  1. “ARRC Announces Recommendation of a Spread Adjustment Methodology for Cash Products,” Alternative Reference Rates Committee, April 8, 2020. Access at:  https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC_Spread_Adjustment_Methodology.pdf 
  2. Ibid. 
  3. Ibid.
  4. Ibid.
  5. Ibid. 
  6. Ibid. 
  7. Ibid. 
  8. Ibid.

Newsletter Author: Venetia Woo; Mairi Bryan

Newsletter Contact Person: Venetia Woo 

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