The LIBOR transition plods onward. Last Wednesday, the Alternative Reference Rates Committee (ARRC) announced its recommended spread adjustment methodology for cash products referencing LIBOR. Regulators around the world have been clear: interim LIBOR replacement deadlines might slip, but LIBOR’s days are still numbered. At the end of March, which feels like ten thousand years ago, the Financial Conduct Authority said that “[t]he central assumption that firms cannot rely on LIBOR being published after the end of 2021 has not changed and end-2021 should remain the target date for all firms to meet.” Amid the constant upheaval as a result of the coronavirus pandemic, isn’t it nice to know that some things aren’t changing?
The ARRC’s recommended methodology—aligned with the International Swaps and Derivatives Association’s (ISDA) methodology for derivatives—will use a historical median over a five-year lookback period calculating the difference between LIBOR and SOFR. For consumer products only, the ARRC is additionally recommending a one-year transition period. The ARRC also promised that it will publish more details about the final recommendation in the coming weeks.
A consistent spread adjustment methodology between cash products and derivatives is a good thing. There remains some disconnect between the two until ISDA adopts the ARRC’s recommended pre-cessation LIBOR replacement trigger. This is because the spread adjustment will be set on the day that the LIBOR replacement trigger occurs and if derivatives and cash products transition on different days each may have different spread adjustments. There’s significant hope of movement here. ISDA recently concluded a second consultation on the issue (which is a remarkable step considering that ISDA already failed to find market consensus in their first consultation). On the other hand, ISDA adopting the ARRC’s recommended pre-cessation replacement trigger does not address the disconnect between legacy cash products (and all cash products not using the ARRC’s recommended language) and derivatives.