ARRC offers a path forward to help market participants manage their efforts and effectively transition from LIBOR.
On May 27th, 2020 the Alternative Reference Rate Committee (ARRC) developed a set of recommended best practices to help market participants to prepare for the cessation of U.S. Dollar (USD) LIBOR by the end of 2021.1 The document recommends timelines for ending the use of USD LIBOR and steps to be taken by market participants for an effective transition.2 This document reflects input received from various ARRC working groups and market participants, and the recommendations should be used as guidelines by firms to organize their operations to encourage strong controls, increase market integrity and promote a strong transition from LIBOR.3 They also aim to aid industry dialogue, particularly around client readiness for the transition.4 As stated by the ARRC, these recommendations do not constitute binding rules or regulatory guidance, as each market participant has to decide what is relevant given their size and complexity.5
What this means
The ARRC has stated with 19 months remaining until the 2021 deadline firms should accelerate their transition planning. The Committee is now providing “date-based” guidance on the steps it believes should be taken.6 These include:7
- USD LIBOR cash products should include ARRC-recommended fallback language as soon as possible.
- Third-party technology vendors should complete all necessary enhancements to support Secured Overnight Financing Rate (SOFR) by December 2020.
- New products referencing LIBOR should stop in the first half of 2021.
- Contracts specifying a replacement rate should disclose the selection of that rate at least six months prior to the date it is selected.
In issuing these recommendations the ARRC recognizes there are certain contingencies to be satisfied for certain timelines to be met so, in addition, they are issuing a set of “Objectives” so these are satisfied.8
- Institutions should take positive steps to transition away from USD LIBOR within recommended timelines and across products:9
- Floating Rate Notes – for new issuances with maturities after December 31st, 2021, all should include ARRC-recommended fallback language by June 30th, 2020. Third-party technology enhancements to support SOFR should be completed by June 30th, 2020. No floating rate notes using USD LIBOR should be issued after December 31st, 2020, and where necessary parties should disclose the replacement rate and the spread methodology that they intend to select at least six months prior to the date the replacement rate is selected.
- Business Loans – for new issuances of all non-consumer loans with maturities after December 31st, 2021, “hardwired” ARRC recommended fallback language should be included as soon as possible, but not later than September 30th, 2020. Third-party technology enhancements to support SOFR should be completed by the same date, and no business loans using USD LIBOR (and maturing after 2021) should be issued after June 30th, 2021. Similarly, spread methodology and replacement rates are to be disclosed to all parties at least six months prior to the rate being selected.
- Consumer Loans – new closed-end residential mortgages referencing USD LIBOR should include ARRC fallback language recommendations by June 30th, 2020, and student loans by September 30th, 2020. No new residential mortgages using USD LIBOR and maturing after 2020 should be accepted after September 30th, 2020. Third-party vendors should complete enhancements, including the ability to use SOFR and USD LIBOR concurrently by September 30th, 2020. By December 31st, 2020, institutions issuing or servicing consumer loans should have notifications and outreach programs in place so these programs are compliant with consumer regulations.
- Securitizations – all securitizations should include recommended ARRC fallback language as soon as possible, or no later than one month after the publication of this document, and have third-party vendors complete enhancements to support SOFR, including compounding and trading, by December 31st, 2020. No floating rate securitizations using USD LIBOR should be issued after June 30th, 2021 and, similarly, replacement rates and spread methodologies should be disclosed at least six months prior to the rate being selected.
- Derivatives – market participants in cleared and uncleared derivatives should adhere to the International Swaps and Derivatives Association (ISDA) IBOR Fallback Protocol no later than four months after definitions are published. Dealers should promote liquidity and access to SOFR derivatives products by September 30th, 2020 for streaming SOFR swaps, December 31st, 2020, for USD collateral in interdealer Credit Support Annexes (CSAs), making markets in swaptions, caps and floors by December 31st, 2020, and changing the market convention for quoting USD derivative contracts from LIBOR to SOFR by March 31st, 2021. No new LIBOR derivatives trades, unless for risk or default management of legacy LIBOR positions, should be issued after June 30th, 2021.
- Institutions should have clear internal transition programs in place to transition away from USD LIBOR across all business lines, and there should be a clear assessment of all exposures.10
- Institutions should prepare a plan with clear internal deadlines to prepare for LIBOR cessation including:11
- Establish an enterprise-wide program across functions and businesses and mitigate risk of transition for product and client exposure.
- Implement a robust governance framework with accountable senior executives to oversee the delivery and implementation of the firm’s LIBOR transition program.
- Develop and implement a strategy to communicate with both internal and external stakeholders.
- Monitor LIBOR-linked exposures and develop capabilities to value SOFR- based products.
- Develop a strategy for transitioning the existing portfolio of LIBOR products and create new products based on SOFR.
- Identify, measure, monitor and control financial and nonfinancial transition risks.
- Understand the financial, customer and legal impacts of the transition and plan implementation to move from LIBOR to SOFR.
- Develop a plan for the large-scale operating model, data and technology implications.
- Determine accounting and reporting considerations.
- Determine tax and regulatory reporting considerations.
- In establishing a transition plan, institutions should refer to the ARRC’s “Practical Implementation Checklist for SOFR Adoption.”
- Institutions should be aware of all ARRC recommendations and should incorporate ARRC recommended conventions into new contracts. Firms should also have ongoing dialogue with stakeholders to promote awareness and preparedness.12
As stated in the introduction, these guidelines and recommendations do not constitute binding rules or regulatory guidance. What they offer is a path forward to help market participants manage their efforts and effectively transition from LIBOR with greater confidence and less disruption.
- “ARRC Recommended Best Practices for Completing the Transition from LIBOR,” Alternative Reference Rates Committee, May 27, 2020. Access at: https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC-Best-Practices.pdf.
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