By Jacqueline Cook, Senior Knowledge Development Lawyer
Following much anticipation, the Alternative Reference Rate Committee (ARRC) has announced its official recommendation of the CME Group’s forward-looking Secured Overnight Financing Rate (SOFR) term rates (SOFR Term Rates). Market participants should now have "all the tools"[1] needed to transition to US dollar (USD) SOFR.
Earlier this week, ARRC issued two press releases:
- publishing (a) conventions for SOFR Term Rates and (b) best practice recommendations for the use of SOFR Term Rates, and announcing the SOFR First Convention switch for USD linear swap trading;[2] and
- recommending CME Group SOFR Term Rates and publishing a factsheet on key steps and milestones for the LIBOR transition.[3]
ARRC’s announcement has been welcomed as "an important milestone for the industry and the continued development of the broader SOFR ecosystem."[4]
Why is this so significant for trade finance?
While it is clear to those working with trade finance products that forward-looking rates are essential in certain sectors and geographies, there was a short period earlier this year when it was unclear whether there would be an alternative term rate to replace USD LIBOR. As many international trade finance transactions are conducted in USD, forward-looking rates are an essential tool for a smooth transition away from LIBOR. So, ARRC’s recommendation means that, whether a transacting party is regulated or not, there is an internationally recognised set of forward-looking term rates that can be used as the basis for interest rates, discount rates and default rates for trade finance.
What tools can I use for USD transactions?
Having sought feedback from various stakeholders as to the viability of replacing USD LIBOR with SOFR compounded in arrears for lending transactions, ARRC acknowledges that a backward-looking overnight rate may not necessarily be appropriate for trade and export finance transactions where certainty is key. This is particularly the case for trade finance loans, middle market loans and multi-lender facilities, which might be better suited to the use of SOFR Term Rates.
What about timing?
The published dates for the cessation of certain LIBOR tenors for USD have not changed, and ARRC still recommends that regulated entities use SOFR for new USD transactions to be entered into after 31 December 2021. However, USD LIBOR will still be available for the most common tenors until June 2023 for legacy contracts that have been difficult or impossible to amend. That said, US and UK regulators are encouraging an early move to SOFR, both for new transactions and for amendments to legacy contracts, so that they are ready to use SOFR Term Rates or SOFR compounded in arrears from the first interest period in 2022.
What next?
So, now that we know there is an alternative forward-looking term rate for USD LIBOR, it is time to put this on your agenda. If you are looking at switching existing USD LIBOR transactions to SOFR Term Rates, we would be happy to work with you on the drafting for your bespoke documentation.
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[1] Tom Wipf, ARRC Chairman and Vice Chairman of Institutional Securities at Morgan Stanley.
[2] 26 July 2021, ARRC Press Release Convention Switch Update
[3] 29 July 2021, ARRC Press Release Term SOFR
[4] Sean Tully, CME Group Global Head of Financial and OTC Products, 29 July 2021. See CME Term SOFR Reference Rates at www.cmegroup.com/termsofr.
