ARRC Announces Recommendation of a Spread Adjustment Methodology for Cash Products
At its April meeting, the Alternative Reference Rates Committee (ARRC) agreed on a recommended spread adjustment methodology for cash products referencing U.S. dollar (USD) LIBOR. The ARRC’s recommended methodology is for market participants’ voluntary use, 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 Secured Overnight Financing Rate (SOFR) can be selected as a fallback.
Following its consideration of feedback received on its public consultation, 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. The inclusion of a transition period for consumer products was endorsed by many respondents, including consumer advocacy groups.
“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,” said Tom Wipf, ARRC Chair and Vice Chairman of Institutional Securities at Morgan Stanley. “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.”
The ARRC made this initial recommendation after conducting an extensive public consultation, during which more than 60 responses were received from consumer advocacy groups, asset managers, corporates, banks, industry associations, government-sponsored entities, among others.
In the coming weeks, the ARRC 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.