The Alternative Reference Rates Committee (ARRC) today released a consultation on spread adjustment methodologies for cash products referencing U.S. dollar (USD) LIBOR. These spread adjustments are intended for use in USD LIBOR contracts that have incorporated the ARRC’s recommended hardwired fallback language, or for legacy USD LIBOR contracts where a spread-adjusted SOFR can be selected as a fallback.
The consultation proposes a static spread adjustment that would be implemented at a specific time on or before USD LIBOR’s cessation and would make the spread-adjusted version of the Secured Overnight Financing Rate (SOFR) comparable to USD LIBOR. In doing so, the spread adjustment would minimize the expected change in the value of contracts as a result of shifting from USD LIBOR to SOFR. SOFR is the ARRC’s recommended alternative to USD LIBOR. The ARRC has committed to making sure that its recommended spread adjustments and the resulting spread-adjusted rates are published and made publicly available.
“A spread adjustment will minimize changes in value that would result from an inevitable switch to SOFR at the point of transition,” said Tom Wipf, ARRC Chair and Vice Chairman of Institutional Securities at Morgan Stanley. “I urge market participants to closely assess the different methodological options and provide feedback, to help the ARRC determine which approach is the most fair and precise.”
The finalized methodologies would be applied to each USD LIBOR tenor separately at the time of a trigger event. This means that the final recommended spread adjustments for each USD LIBOR tenor may differ, though the underlying methodology for calculating them would be the same.
To help market participants evaluate potential methodologies, the consultation presents indicative, historical analysis to demonstrate how different methods would have worked in the past. The consultation also poses questions regarding methods for calculating the long-run level of the spreads, the time period of data used to estimate the long-run level, and the speed at which the spread adjustment should be expected to adjust from the last value of USD LIBOR to a long-run level, called a “transition period” in the consultation.