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ARRC Consults on Spread Adjustment
January 31, 2020 | Issue No. 62

Much of the thought in the LIBOR phase-out process has been on drafting contract terms that identify an agreed-upon replacement benchmark and then effecting the transition. One aspect that has received less attention is the necessary margin adjustment that should accompany a change in the benchmark. Because LIBOR is an unsecured interbank lending rate and SOFR, as the name suggests, is based on secured transactions, there inevitably exists a LIBOR-SOFR basis. Without an accompanying margin adjustment, the transition to SOFR would, under normal circumstances, result in a reduced interest rate on a loan.

The Federal Reserve's Alternative Reference Rates Committee (ARRC) is tackling the topic in its recently published ARRC Consultation on Spread Adjustment Methodologies for Fallbacks in Cash Products Referencing USD LIBOR. The publication provides an opportunity for market participants to comment on the appropriate methodology for determining the spread adjustment. Our colleagues at the Cadwalader Cabinet summarized the consultation here.

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