Expand
Resize
Add to favorites
LIBOR is one of the most commonly used reference rates in the global financial markets along with other interbank offered rates (IBORs). However, the United Kingdom’s Financial Conduct Authority announced that it would no longer persuade or compel banks to submit LIBOR as of the end of 2021. In the United States, the Alternative Reference Rates Committee (ARRC) convened by the Federal Reserve identified the Secured Overnight Financing Rate (SOFR) as its preferred alternative reference rate to US dollar LIBOR.
In response to the anticipated cessation of certain IBORS, industry working groups, such as the ARRC, are developing proposals for alternative reference rates (such as SOFR) and “fallback language” for reporting entities to insert as provisions into new or existing agreements that refer to rates expected to be replaced. The fallback language specifies how a replacement rate will be identified (i.e., interest rate reset feature) once a trigger event (such as LIBOR no longer being quoted) occurs. Some recent issuances of loans and securities are already indexed to SOFR.
As discussed in DH 4.4, debt instruments are required to be assessed for embedded derivatives, which may require bifurcation from the host contract if the interest rate reset features are not considered to be clearly and closely related to the host contract.

4.9.1 ARRC SEC consultation on SOFR reset features

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 4-8 summarizes the interest rate reset features included in the submission.
Figure DH 4-8
Summary of SOFR reset features
Rate type
Description of the rate
Term SOFR
Pays interest based on a forward-looking term SOFR for the corresponding tenor.
Compound SOFR in arrears
Pays interest based on a daily compounded average SOFR for the corresponding tenor implemented in arrears.
Compound SOFR in advance
Pays interest based on a daily compounded average SOFR for the corresponding tenor implemented in advance.
Average SOFR in advance
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.
A forward-looking term SOFR, if one were to become available, would reset periodically based on the tenor (e.g., three month SOFR), similar to term LIBOR. 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.
Expand

Welcome to Viewpoint, the new platform that replaces Inform. Once you have viewed this piece of content, to ensure you can access the content most relevant to you, please confirm your territory.

Your session has expired

Please use the button below to sign in again.
If this problem persists please contact support.

signin option menu option suggested option contentmouse option displaycontent option contentpage option relatedlink option prevandafter option trending option searchicon option search option feedback option end slide