The ARRC previously issued recommended fallback language for voluntary use by market participants in contracts that reference USD LIBOR (see Legal Update, ARRC Publishes LIBOR Transition Progress Report and Issues Update on Forward-Looking Term SOFR Rate. The ARRC has also made separate recommendations of language appropriate for LIBOR-based floating rate notes, bilateral business loans, syndicated loans, securitizations, residential adjustable rate mortgages, and private student loans (see Legal Updates, ARRC Issues Recommended Hardwired Fallback Language for Syndicated and Bilateral Business Loans and Publishes Suggested LIBOR-to-SOFR Swap Fallback Formula, ARRC Releases New Fallback LIBOR Language for Residential ARM Loans, and ARRC Releases Recommended Fallback Language for Student Loans. These recommendations were made after widespread market consultation, which reflected that the clear majority of respondents preferred to fallback to an ARRC-recommended SOFR term rate to support the smooth transition of legacy contracts away from LIBOR.

For this reason, although the ARRC recognizes that falling back to other forms of SOFR would align with its principles, under the recommended contract language for floating rate notes, bilateral and syndicated business loans, and securitizations, the first step of the fallback waterfall is a forward-looking SOFR-based term rate (provided one has been recommended in the appropriate tenor) by the ARRC.

Accordingly, following the formal recommendation of the SOFR term rate, legacy contracts that have adopted the ARRC’s fallback language without modification to the rate waterfall will, if the relevant tenor exists, fall back to the SOFR term rate once the contractual LIBOR replacement date occurs.

For new contracts, the ARRC continues to recommend SOFR for all products, and as a general principle recommends that market participants use overnight SOFR and SOFR averages given their robustness, particularly in markets where there has been successful adoption of these rates, such as floating rate notes, consumer products including adjustable-rate mortgages and student loans, and most securitizations.

The ARRC also recommends the use of overnight SOFR and SOFR averages in instances where a party wishes to hedge in the most efficient and transparent manner. However, the ARRC also supports the use of the SOFR term rate in areas where use of overnight and averages of SOFR has proven to be difficult.

As previously noted in the ARRC recommended conventions, the ARRC also supports in the ARRC best practices the use of SOFR term rate in addition to other forms of SOFR for business loan activity, particularly for multi-lender facilities, middle market loans, and trade finance loans, where transitioning from LIBOR to an overnight rate has been difficult and where use of a term rate could be helpful in addressing such difficulties. The ARRC also recognizes that the SOFR term rate may be appropriate for certain securitizations that hold underlying business loans or other assets that reference the SOFR term rate and where those assets cannot easily reference other forms of SOFR.

The ARRC does not support the use of the SOFR term rate for the vast majority of the derivatives markets, because these markets already reference SOFR compounded in arrears and transitioning derivatives markets to the more robust overnight risk-free rates (RFRs) is essential to ensure financial stability, as emphasized by the Financial Stability Board (FSB) (see Legal Update, FASB Adds SOFR to List of US Benchmark Rates Eligible for Hedge Accounting). The ARRC recommends that any use of SOFR term rate in derivatives be limited to end-user-facing derivatives intended to hedge cash products that reference the SOFR term rate. As noted, this limitation is intended to avoid use of the SOFR term rate that is not in proportion to, or materially detracts from, the depth of transactions in the underlying derivatives markets that are essential to the construction of the SOFR term rate over time.