On Friday April 21, 2023, the ARRC issued a summary and update to its July 2021 Term SOFR scope of use best practice recommendations.

The ARRC’s original recommendations provided end users with the ability to use Term SOFR in their business loans and any derivatives to hedge Term SOFR business loans or legacy LIBOR products that have converted to Term SOFR. The latest update does not changes this but provides for end users to enter into Term SOFR-SOFR basis swaps (but not other Term SOFR derivatives) even when they do not hold Term SOFR cash assets that they are seeking to hedge. This will enable dealers to lay off some Term SOFR risk to other market participants but is expected to continue to ensure that use of Term SOFR remains generally limited. 

Interdealer trading of Term SOFR (including of Term SOFR basis swaps) is still not permitted, as such activity could compromise the robustness of Term SOFR. 

In summary use of Term SOFR is limited to the following, specific purposes: 

1. As a fallback rate for legacy LIBOR cash products 
2. For new use in business loans, and also certain securitizations that hold underlying Term SOFR assets
3. For use in derivatives only if issued to end-users to hedge cash products that reference the Term SOFR rate. 

The ARRC continues to recommend use of overnight SOFR and SOFR averages for all products recognising the ability to use Term SOFR in the use cases mentioned above.

The recommendations have been endorsed by the Financial Stability Oversight Council and the Financial Stability Board.

The ARRC noted that dealers offering Term SOFR rate derivatives to end users have been able to warehouse the risk associated with such offerings, generally offering such hedges at a cost of a few basis points relative to SOFR OIS. The ARRC recognised the need to expand on the use cases to ensure the 'warehouse' does not get too full and negatively impact the market.