“The SEC staff statement emphasizes the time sensitivity as we approach the 2021 deadline, and the importance for financial firms to review their risk exposures and to proactively address these risks.”

On July 12th, 2019, the staffs of the Securities and Exchange Commission’s (SEC) Division of Corporate Finance, Division of Investment Management (IM Division), Division of Trading and Markets, and Office of Chief Accountant, issued a statement relating to the expected 2021 cessation of the LIBOR benchmark rate.1 The SEC in its statement emphasized the responsibility of all market participants, including investment companies, investment advisers, broker-dealers, banks and insurance companies, to be prepared to transition from the London Interbank Offered Rate (LIBOR) to the Secured Overnight Financing Rate (SOFR), or other alternative benchmark rates, to reduce risk exposure and any potential impacts to clients and shareholders.2 The SEC stated that the risks associated with the LIBOR discontinuation are expected to be exacerbated if the work necessary for an orderly transition is not completed in a timely manner.3 The Staff made clear, that although this SEC document focused on LIBOR, market participants should also examine their exposures to other global benchmark rates undergoing transition, and stay informed and in communication with global regulators and industry bodies as the transition progresses.4 

What this means

The SEC Staff statement discusses the importance of all market participants to begin managing their transition away from LIBOR, specifically with regard to analyzing, and replacing or amending existing and future contracts, developing appropriate policies, procedures and operating systems, providing adequate disclosure to investors regarding potential risks, and maintaining accurate financial reporting in hedging and tax activities that may be impacted by the transition.5 

New and Existing Contracts6 

The SEC is encouraging market participants to identify existing contracts that extend past 2021 and assess their exposure to LIBOR, and so identify the potential impact the discontinuation of LIBOR is expected to have on the operation of the contracts, especially where no fallback language exists. For new contracts financial firms should consider referencing an alternative rate to LIBOR, such as SOFR, and in the instance of any future contracts referencing LIBOR, effective fallback language should be included. Both the Alternative Reference Rate Committee (ARRC) and the International Swaps and Derivatives Association (ISDA) have published recommended fallback language for various assets including syndicated loans, securitizations, and swaps and derivatives.  

Policies and Procedures7  

In addition to mitigation efforts relating to new and existing contracts, the SEC Staff statement recommends that market participants identify, evaluate and mitigate the consequences that the LIBOR discontinuation may have on strategy, products, processes and information systems. Firms should assess the impact of financial, operational, legal, regulatory and technology risks, and develop appropriate policies and procedures to address such risks. The SEC Staff statement explains that the ARRC is continuously evaluating additional issues and recommends that market participants should stay informed regarding the findings of the various ARRC working groups.  

Investment Management Guidance8 

The Division of Investment Management together with the Corporate Finance and Trading and Markets divisions, provided guidance that highlighted specific risks that may impact public and private investment companies, and investment advisers that invest in assets tied to LIBOR, such as floating rate debt, bank loans, and LIBOR linked derivatives. The statement emphasizes that if these assets do not contain the appropriate fallback language, the discontinuation of LIBOR could impact the liquidity and value of these investments, and that these risks should be disclosed to investors. The Trading and Markets division is actively monitoring the impact on broker-dealers, central counterparties and exchanges, and encourages these entities to analyze how the discontinuation of LIBOR is expected to impact their business, systems, models, processes, risk management frameworks, and clients. 

Office of the Chief Accountant (OCA) Guidance9 

The OCA has highlighted the impacts of transitioning away from LIBOR to another benchmark on a firm’s financial reporting, including, modifications of terms within debt instruments, hedging activities, valuation models, and potential tax consequences. The OCA notes that the Financial Accounting Standards Board (FASB) has issued an Accounting Standards Update that allows for the Overnight Index Swap (OIS) rate based on SOFR OIS to be designated as a benchmark rate for hedge accounting purposes. The statement encourages market participants to remain involved and engaged with the standard setting process.  

Conclusion 

As regulators and market participants seek to avoid business and market disruption resulting from the discontinuation of LIBOR, implementing alternative benchmark rates, and assessing the impact across business functions has taken on an urgency. The SEC staff statement emphasizes the time sensitivity as we approach the 2021 deadline, and the importance for financial firms to review their risk exposures and to proactively address these risks. In addition to the SEC, other global financial market regulators, and industry groups are also focused on encouraging market participants to proactively address and mitigate any risks associated with the LIBOR transition.  

References 

  1. “SEC Staff Issues Statement on LIBOR Transition; Practical Considerations for Investment Companies, Investment Advisers and Other Financial Institutions in Proactively Addressing LIBOR Cessation and Transition,” JD Supra, September 25, 2019. Access at: https://www.jdsupra.com/legalnews/sec-staff-issues-statement-on-libor-36472/ 
  2. “Staff Statement on LIBOR Transition,” U.S. Securities and Exchange Commission, July 12, 2019. Access at: https://www.sec.gov/news/public-statement/libor-transition 
  3. Ibid 
  4. Ibid 
  5. “SEC Staff Issues Statement on LIBOR Transition; Practical Considerations for Investment Companies, Investment Advisers and Other Financial Institutions in Proactively Addressing LIBOR Cessation and Transition,” JD Supra, September 25, 2019. Access at: https://www.jdsupra.com/legalnews/sec-staff-issues-statement-on-libor-36472/  
  6. “Staff Statement on LIBOR Transition,” U.S. Securities and Exchange Commission, July 12, 2019. Access at: https://www.sec.gov/news/public-statement/libor-transition 
  7. Ibid 
  8. “SEC Staff Issues Statement on LIBOR Transition; Practical Considerations for Investment Companies, Investment Advisers and Other Financial Institutions in Proactively Addressing LIBOR Cessation and Transition,” JD Supra, September 25, 2019. Access at: https://www.jdsupra.com/legalnews/sec-staff-issues-statement-on-libor-36472/ 
  9. “Staff Statement on LIBOR Transition,” U.S. Securities and Exchange Commission, July 12, 2019. Access at: https://www.sec.gov/news/public-statement/libor-transition  

Newsletter Author: Venetia WooMairi Bryan

Newsletter Contact Person: Venetia Woo 

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