On October 1, 2019, the LSTA released to its members a draft “concept credit agreement” illustrating how a compounded average of daily SOFRs calculated in arrears might be incorporated into the LSTA’s form of Credit Agreement (a reference document that the LSTA has long maintained for basic syndicated lending provisions).

A few notes on the initial LSTA concept credit agreement:

  • Backward looking versus forward looking: The “compounded SOFR in arrears” rate can’t be calculated until the end of an interest period, which differs from the LIBOR rate calculation (a forward looking rate) and will be a challenge for financial institutions to operationalize.  Several factors, however, led the LSTA to use compounded SOFR in arrears in this initial SOFR-based concept credit agreement: (1) it will be incorporated into ISDA standard definitions in 2020 as the standard fallback rate for USD LIBOR derivatives; (2) it is already incorporated into the first US cash products to utilize a SOFR based rate (floating rate notes); and (3) it provides lenders with a time value of money calculation for their loans most closely matching the stated interest period.
  • Definition and measurement conventions: The SOFR definition in the LSTA concept credit agreement (1) follows the general formula used by the Federal Reserve Bank of New York in publishing its compounded SOFR data, (2) includes an observation shift (i.e. commencing the SOFR observation period two business days (or other period determined by the parties) prior to the interest period start date) to enable reference to a compounded SOFR index published by the Federal Reserve Bank of New York and (3) includes a floor concept in the definition of “SOFR” rather than “Compounded SOFR”, a departure to how floors are captured in the LIBOR context.
  • No Go-Forward Spread Adjustments: The LSTA concept credit agreement is based on a SOFR rate + an applicable margin, without any “spread adjustments”, which are only necessary in LIBOR fallback calculations to bring a SOFR based rate into line with historical LIBOR values (see description of latest ARRC release on spread adjustments)
  • No Match Funding Provisions: Unlike LIBOR, SOFR is not based on a “cost plus funding” concept, so customary LIBOR market disruption and break funding provisions are likely inapplicable and therefore not included in the initial draft LSTA concept credit agreement.

For more detail, please visit www.lsta.org (portions of which are member-only access). We will be keeping up with key LSTA positions and developments as part of our ongoing tracking and posting on the LIBOR replacement process.

Link to post – ARRC Consultation on Spread Adjustment Methodologies dated January 30.