In April 2020, the ARRC submitted a consultation request to the Office of the Chief Accountant of the SEC. The submission focused on whether certain interest rate reset features based on SOFR would be required to be bifurcated and accounted for as derivative instruments pursuant to
ASC 815. The submission focused on three interest rate reset features for commercial products and one interest rate reset feature for consumer adjustable-rate mortgage loans that the ARRC has recommended industry participants adopt.
Figure DH 4-6 summarizes the interest rate reset features included in the submission.
Figure DH 4-5
Summary of SOFR reset features
Rate type |
Description of the rate |
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Pays interest based on a forward-looking term SOFR for the corresponding tenor.
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Pays interest based on a daily compounded average SOFR for the corresponding tenor implemented in arrears.
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Pays interest based on a daily compounded average SOFR for the corresponding tenor implemented in advance.
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Pays interest based on the trailing 30 or 90 days SOFR simple or compound average, which resets every 6 months and is set 45 days before the beginning of the interest period.
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A forward-looking term SOFR would reset periodically based on the tenor (e.g., three month SOFR would reset every 3 months). The interest rate paid on the payment date would be known prior to the beginning of the interest accrual period and remain fixed until the next reset date.
A compounded SOFR in arrears rate is determined at the end of an interest rate accrual period. For example, if an instrument indexed to compounded SOFR in arrears pays interest quarterly, the interest rate for the first calendar year quarter would be based on the daily compounded average of SOFR rates during the time period from January 1 through March 31.
Compounded SOFR in advance means the interest rate applied during the interest accrual period is based on the daily compounded average of SOFR during the prior interest accrual period. Since the rate is set “in advance,” the interest rate is determined at the beginning of the interest accrual period and is fixed until the next reset date. For example, if an instrument indexed to compounded SOFR in advance pays interest quarterly, the interest rate for the third calendar quarter would be based on the daily compounded average of SOFR during the period from April 1 through June 30 (i.e., Q2).
Average SOFR in advance means the interest rate applied during the interest accrual period is based on either the daily simple or daily compounded average of SOFR from a specified period. However, the reset frequency and period over which the average is calculated may not match. Since the rate is set “in advance,” the interest rate is determined prior to the beginning of the interest accrual period and is fixed until the next reset date. For example, if an instrument (e.g., a consumer adjustable-rate mortgage) indexed to the daily simple average of SOFR in advance resets semi-annually on June 30, the new rate would set 45 days in advance of June 30 (i.e., April 15) based on the daily simple average of SOFR during the prior 90-day period (i.e., January 15 through April 15).
The SEC staff did not object to the ARRC’s conclusions that the SOFR interest rate reset features noted above are considered terms of the host contract and therefore do
not represent embedded derivatives that require further analysis under
ASC 815. The SEC staff’s response was limited to the fact patterns discussed above. We understand that the SEC’s view was based, in part, on the current expectation that the SOFR markets will develop to include interest rate reset features consistent with these features and therefore, these SOFR interest rate reset features would be considered terms of the host contract. However, as the SOFR market develops, changes in facts and circumstances could lead to different conclusions which may need to be reassessed.