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Authored by: Simon Deane and Natalie Chan
On 21 April 2023, the Alternative Reference Rates Committee (“ARRC”), a group of private-market participants convened by the Federal Reserve Board and the Federal Reserve Bank of New York in 2014 to lead the LIBOR transition in the United States, issued an update (“Update”) on the Best Practice Recommendations for, among other things, the use of the Secured Overnight Financing Rate (“SOFR”) and its term rates (“Term SOFR”), following the ARRC’s formal recommendation to use Term SOFR in July 2021.
The Update provides clarifications to support the use of Term SOFR as a fallback for, among others, legacy LIBOR cash products, and for new business loans and securitizations that hold underlying Term SOFR assets. The ARRC recommends use of overnight SOFR and SOFR averages in new issuances of all other products but NOT Term SOFR.
The ARRC also recommends the use of overnight SOFR and SOFR averages where a party wishes to hedge in the most efficient and transparent manner. It does not support the use of Term SOFR for the majority of derivatives markets. Any use of Term SOFR-SOFR basis swaps should be limited to dealers facing non-dealers, and any use of other Term SOFR derivatives should be specifically limited to non-dealer facing transactions intended to hedge an end user’s direct cash product exposure to Term SOFR. The ARRC recommends that use of all Term SOFR derivatives between dealers be strictly avoided. The limitations are intended to avoid use that is not in proportion to, or materially detracts from, the depth of transactions in the underlying derivatives market that are essential to the construction of the Term SOFR rates over time.
For more details on the Update, please see here.
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