Secured Overnight Financing Rate (SOFR) Benchmark Succession Clauses

By: The Practical Guidance Finance Team

This article discusses trends in benchmark succession clauses in recent credit agreements using benchmark rates other than the London Interbank Offered Rate (LIBOR). Credit agreements typically provide for replacing the benchmark interest rate used in the agreement under certain circumstances.

Credit agreements originated at the end of 2021 and into 2022 are using benchmark interest rates other than LIBOR, with the Secured Overnight Financing Rate (SOFR) being the frontrunner for replacing LIBOR. These credit agreements contain benchmark replacement setting clauses (also sometimes referred to as reference rate replacement clauses) in the event the SOFR term rates (Term SOFR) or the current benchmark needs to be replaced for various reasons.

Benchmark replacement clauses in credit agreements typically set forth the triggers for replacement of the benchmark rate, the replacement rate or waterfall of potential replacement rate options, the required level of consent of the parties, a provision for making conforming changes to the loan documents, a clause allowing changes to an interest rate tenor without changing the benchmark, and definitions needed to implement the benchmark replacement clause. Such clauses generally provide for replacing the benchmark interest rate in the event the benchmark administrator ceases publication of such rate or such benchmark is no longer representative of the market. If a replacement rate is not implemented, loans at the affected rate convert to the base rate. The base rate has been historically always higher and not desired by borrowers for other than short-term financing.

In the years leading up to the cessation of LIBOR, benchmark replacement setting clauses were focused on replacing LIBOR. The triggering events were based on the cessation of LIBOR, and the provisions were typically either hardwired (automatic upon the trigger) or required an amendment. With new credit agreements containing SOFR or other alternative rates as the benchmark, the benchmark replacement setting clauses have also shifted to provisions not involving LIBOR. While not as critical as when replacing LIBOR due to cessation, benchmark replacement clauses remain relevant in the event that SOFR, or whatever rate is used in a credit agreement, does not turn out to be an available or representative benchmark.

Background

With the cessation of some tenors of LIBOR at the end of 2021 and all tenors by July 1, 2023, lenders and borrowers have had to transition from LIBOR to another rate. The Board of Governors of the Federal Reserve System and the Federal Reserve Bank of New York established the Alternative Reference Rate Committee (ARRC) to recommend and promulgate an alternative rate. The ARRC has settled on SOFR as the recommended replacement for LIBOR.

Initially, SOFR was offered as a daily rate, but as of July 2021, Term SOFR is a forward-looking term rate that more closely matches the tenors of LIBOR.

LIBOR succession clauses in credit agreements operated to replace LIBOR with a new benchmark either automatically without further consent (hardwired approach) or through agreement on
an amendment (amendment approach). Through the operation of LIBOR succession clauses, most existing credit agreements have shifted to SOFR as the new benchmark. Likewise, new credit agreements are emerging with Term SOFR as the benchmark. So rather than LIBOR succession clauses, new credit agreements contain benchmark replacement setting clauses or reference rate replacement clauses, with Term SOFR as the initial benchmark or reference rate. These clauses address the circumstances under which the benchmark needs to be replaced and the procedure for replacing the benchmark or reference rate.

Recent Developments

Despite the shift away from LIBOR and the critical importance of benchmark replacement setting clauses, these clauses remain important in the event the market does not embrace SOFR or other rates now being used in credit agreements, or if the availability of such rates or their tenors changes. New credit agreements at the end of 2021 and into 2022 contain benchmark replacement settings clauses that begin with Term SOFR (or another agreed rate) as the benchmark.

The Loan Syndications and Trading Association (LSTA) has promulgated a concept credit agreement using Term SOFR as the interest rate rather than LIBOR. The LSTA’s Term SOFR Concept Document dated August 25, 2021, offers example language for a benchmark replacement setting provision with Term SOFR as the initial benchmark. The LSTA’s benchmark replacement clause offers two options, depending on the benchmark replacement rate alternatives—one is an amendment approach and the other is a hybrid hardwired approach with a negative consent amendment provision. The first option, upon a benchmark transition event, permits the administrative agent and the borrower to amend the credit agreement with a benchmark replacement and adjustment that they agree upon, considering recommendations of any relevant governmental authority and market conventions. In the second option, upon a benchmark transition event, the benchmark automatically switches to daily simple SOFR without any amendment, action, or consent. However, if daily simple SOFR is not available, then the benchmark replacement is a rate and adjustment agreed upon by the administrative agent and the borrower through an amendment, considering recommendations of any relevant governmental authority and market conventions. Under the latter part of the second option, notice is given to the lenders of such benchmark replacement and the credit agreement is amended with the new rate unless the required lenders object in writing within the time specified.

The LSTA definition of benchmark transition event for purposes of triggering a benchmark replacement means the occurrence of one or more of the following events:

• The administrator of the benchmark publicly announces that it will cease to provide all tenors of the benchmark rate (and there is no successor administrator).
• A regulatory body that has authority over the administrator publicly announces that the administrator will cease to provide all tenors of the benchmark (and there is no successor administrator).
• The administrator or regulatory body that has authority over the administrator publicly announces that all tenors of such benchmark will no longer be representative, in compliance with, or aligned with the International Organization of Securities Commissions Principles for Financial Benchmarks.

The remaining terms and definitions of the LSTA benchmark replacement settings provision cover conforming changes to the loan documents, the standards for the administrative agent in making determinations, unavailability of a tenor of the benchmark, and procedure during a benchmark unavailability period.

The following are some terms that are common to many of the recent benchmark replacement setting clauses appearing in new credit agreements.

Triggering Events

Benchmark replacement typically is triggered upon the occurrence of certain events that are commonly enumerated in the definition of benchmark transition event or a similar term. Trigger events include:

• A public statement or publication that the administrator of the benchmark has or will cease to provide all available tenors of such benchmark, permanently or indefinitely, and there is no successor administrator
• A public statement or publication by the regulatory body with authority over the administrator of the benchmark, the Federal Reserve Board, the Federal Reserve Bank of New York, an insolvency official, resolution authority, court, or entity with insolvency or resolution authority with jurisdiction over the administrator states that the administrator will cease to provide all tenors of the benchmark and there is no successor administrator
• A public statement or publication by the regulatory body over the administrator of such benchmark announces that all available tenors of such benchmark are no longer representative of the market 

If one of the enumerated benchmark transition events occurs, it gives rise to the benchmark replacement.

Benchmark Replacement

The operative part of the benchmark succession setting clause is the provision for replacing the benchmark rate. This occurs upon one of the triggering events, as discussed above. The benchmark replacement terms vary as to which rate will be the replacement and whether replacement occurs automatically or requires an amendment and/or some level of consent. For credit agreements using an amendment approach, the credit agreement defines the benchmark replacement as a rate to be agreed upon between the administrative agent and the borrower, considering recommendations of any relevant government authority or market conventions. Such an amendment may then require a certain level of consent of the lenders, as for any credit agreement amendments. Other credit agreements will provide a waterfall of potential replacement rates in a specified order, with the first rate that the administrative agent can determine being the effective replacement. These credit agreements are using a hardwired approach, provided that the waterfall typically includes a general rate to be agreed upon by amendment as the last potential rate. In such event, the amendment may require some level of consent of the required lenders under the credit agreement, which may be negative consent as provided in the LSTA’s option in the concept credit agreement. For credit agreements having Term SOFR as the initial benchmark and using the waterfall approach, daily simple SOFR is commonly the first alternate benchmark rate. And, if daily simple SOFR cannot be determined by the administrative agent, then an amendment
is needed.

As a side note, a replacement benchmark may require a spread adjustment to make the replacement rate equivalent to the benchmark being replaced. The ARRC has recommended spread adjustments for the initial transition from LIBOR to Term SOFR. In addition, there may be a need for a spread adjustment between Term SOFR and daily simple SOFR, or any benchmark and its replacement. The spread adjustment should be included in the benchmark succession setting clause or its related definitions.

Benchmark Replacement Conforming Changes

Typically, benchmark replacement setting clauses include a provision permitting the administrative agent to make changes to the credit agreement or other loan documents to effect the benchmark replacement. The changes include technical, administrative, or operational changes, such as to definitions that may be needed to implement the change in the benchmark rate. Such changes are made by the administrative agent without the requirement of any consent or action of any other party.

Standards for the Administrative Agent

Most benchmark replacement setting clauses contain a provision addressing the notice requirements and standards for decisions and determinations of the administrative agent. Since the administrative agent may be exercising discretion in the benchmark replacement process, this type of provision sets forth the standards for such discretion by the administrative agent. The administrative agent typically must give notice of benchmark replacement and conforming changes. In addition, the decisions, determinations, or elections of the administrative agent under the benchmark replacement setting provision, including with respect to a tenor, rate, spread adjustment, occurrence of an event, or decision to act or not, typically are conclusive and binding absent manifest error and may be made in its sole discretion, without consent, except as expressly required in the provision.

Unavailability of a Tenor of a Benchmark

Benchmark replacement setting clauses commonly include a provision allowing the administrative agent to change the definition of interest period if a particular tenor of a term rate becomes unavailable, but other tenors are still available. A tenor may become unavailable (1) if the tenor for the benchmark is not displayed on a screen or information service used by the administrative agent to determine the benchmark or (2) if the regulatory supervisor for the administrator of the benchmark publicly announces that any tenor for the benchmark will not be representative of the market. This allows the administrative agent to revise the offered interest periods with respect to a term rate (including Term SOFR) without needing further consent of the other parties and without replacing the benchmark rate in its entirety.

Definitions Relating to Benchmark Replacement

The benchmark replacement setting clause may include some terms that are not already defined in the credit agreement and need to be added with appropriate definitions for use in the clause. Such defined terms may include “Benchmark,” “Benchmark Replacement,” “Benchmark Replacement Date Adjustment,” “Benchmark Transition Event,” and “Benchmark Unavailability Period.” These defined terms are fairly standard but should be tailored to the specific transaction.

The terms “Benchmark” and “Benchmark Replacement” should be defined as the initial benchmark, currently predominantly Term SOFR, and then either a replacement that is to be agreed upon between the administrative agent and the borrower or a waterfall of replacements in the order that they may be determined. The term “Benchmark Transition Event” is key to defining the triggering events, as described above, for when the benchmark rate will be replaced. Additional terms may be needed or revised to accommodate the initial benchmark rate and any spread adjustment and to fit the transaction.

One additional consideration, many credit agreements expressly exclude swap agreements from the definition of loan documents for purposes of the benchmark replacement provisions. The parties may determine that the swap agreements should have their own fallback rate provisions, rather than using the benchmark replacement from the credit agreement.

Action Items/Looking Ahead

When amending existing credit agreements, practitioners should amend the benchmark succession clause to reflect Term SOFR or another rate as the new initial benchmark under the credit agreement and to shift away from the focus on LIBOR succession. For new credit agreements, consider the appropriate benchmark replacement setting clause to include and reference the initial benchmark for the agreement. The parties may want the amendment approach to allow flexibility and have input in the event that the benchmark must be replaced. Or, if more certainty is desired, the hybrid hardwired approach, as discussed in the LSTA’s second option, may be included for an automatic replacement with a fallback to an amendment needing negative consent of the required lenders. In any event, it is still important to include a benchmark succession clause in credit agreements, even now that most agreements have shifted away from LIBOR, to cover potential events resulting in the benchmark becoming unavailable or nonrepresentative of the market. 

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