LIBOR transition update: Financial institutions brace for scrutiny – Newsletters

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introduction
Scope
Notable features of guidance

Comment

introduction

On March 9, 2021, the Federal Reserve Board released Supervision and Regulation (SR) Letter 21-7, which contains tips for reviewers on how to assess a supervised company’s progress in its transition from using the London Interbank Offered Rate (LIBOR). The SR letter asks reviewers to consider issuing surveillance findings and other surveillance actions to companies that are not ready to stop using LIBOR by December 31, 2021.

The SR letter follows the November 30, 2020 publication of a interagency statement on the LIBOR transition, who noted that entering into new contracts referencing LIBOR after December 31, 2021 would create security and soundness risks. The guidelines also follow recent statements about ending LIBOR by:

  • the UK Financial Conduct Authority;
  • the Intercontinental Exchange Benchmark Administration Limited;
  • the International Association of Swaps and Derivatives (ISDA); and
  • the Alternative Reference Rates Committee.

Scope

The Letter SR provides two sets of guidelines on how to assess the LIBOR transition efforts of supervised businesses (e.g., bank holding companies, savings and loan holding companies, branches and US branches of banks. foreign and state banks):

  • big business advice – intended for reviewers who assess supervised businesses with $ 100 billion or more in consolidated assets, including foreign banking organizations with US consolidated assets of $ 100 billion or more; and
  • small business advice – intended for reviewers who assess supervised businesses with consolidated assets of less than $ 100 billion or more, including foreign banking organizations with US consolidated assets of less than $ 100 billion).

All businesses should plan to exit LIBOR. The two sets of guidelines cover six areas of the LIBOR transition:

  • transition planning;
  • measurement of financial exposure and risk assessment;
  • operational preparation and controls;
  • preparation of legal contracts;
  • Communication; and
  • surveillance.

Since the broad directions for large companies are significantly more prescriptive than small companies, the notable characteristics of large companies are summarized below. Broad Business Directions can also help small businesses prepare or assess their LIBOR transition plans.

Notable features of guidance

Reviewers should summarize their findings and recommendations on LIBOR readiness in review reports and, if necessary, conduct additional targeted reviews for overdue companies before the end of 2021. Reviewers should focus on the following areas.

Transition planning
Reviewers should determine if a company has:

  • a governance structure with clearly defined roles and responsibilities; and
  • a project roadmap with defined timelines and milestones.

In addition, the top management of a company is expected to provide an appropriate budget and personnel resources to support preparation for the transition.

Financial exposure measurement and risk management
Companies should accurately measure their financial exposure to LIBOR, including any financial product that refers to LIBOR (for example, investments, derivatives and loans). Exposures must be identified by product, counterparty and business sector and according to whether they are owners or custodians. Companies should be able to identify the proportion of their LIBOR exposure that will end before the relevant tenor expires (i.e. December 31, 2021 or June 30, 2023, as applicable) and set highlight the valuation and hedging challenges that will result from switching from LIBOR to an alternative rate. Foreign companies should also measure the LIBOR exposures recognized or managed in the US operations and quantify the exposures within their US operations relative to the LIBOR exposure of their consolidated foreign parent company.

Operational and supplier issues
Companies should identify all internal and vendor-supplied systems and models that use or require LIBOR as an input and make any necessary adjustments to facilitate the proper functioning of those systems and models before LIBOR ceases. Companies should confirm with their service providers that necessary updates will be available for testing and implementation by December 31, 2021 and establish a contingency plan in cases where service providers cannot provide. a timely solution. Changes to business models should adhere to the sound model risk management practices outlined in SR 11-7 and companies should include progress reports in their transition plans.

Preparation of the legal contract
Companies should identify all contracts that refer to LIBOR and refrain from entering into contracts without alternate language. For contracts which do not have adequate alternate language and which will expire after the relevant content ceases (i.e. December 31, 2021 or June 30, 2023, as the case may be), the A company’s transition plan should address how it will determine the effect of LIBOR termination on these contracts and the steps the company will take to process these contracts prior to LIBOR termination. Companies must show progress in developing their plans and have complete plans well in advance of any tenor’s termination date.

A business that is a “heavy user of derivatives” should consider adhering to the ISDA Interbank Offered Rate (IBOR) fallback protocol and IBOR Fallback supplement to implement robust fallback solutions for old and new derivative contracts. . Companies should identify customers who will not adopt ISDA IBOR and supplement and mitigate the associated risks.

In addition, new LIBOR-based contracts entered into before December 31, 2021 are expected to have robust fallback language that includes a clearly defined alternative benchmark rate after LIBOR is no longer available. Firms involved in syndicated loans should consult with their relevant agent banks to ensure that they appropriately address fallback language in syndicated loan agreements.

The communications
Companies should communicate about the LIBOR transition with their:

  • counterparties;
  • clients;
  • consumers; and
  • internal stakeholders

In addition, companies must comply with applicable regulations (in particular, the guidelines mention compliance with the Loan Truth Act and prohibitions of unfair or deceptive acts or practices). Companies should train their employees on:

  • the LIBOR transition;
  • how the LIBOR transition will affect staff work; and
  • how staff should communicate the implications of the LIBOR transition externally, if applicable.

Companies should also provide “regular updates” to key stakeholders.

Monitoring
The group designated by a company to oversee its LIBOR transition plan should provide timely updates to its senior management and board of directors. In addition, the group should regularly inform the general management and the board of the progress of the plan and alert them of any significant or significant delay. If a company is a foreign entity with more than $ 100 billion in US assets, it must provide updates to its US chief risk officer and the US risk committee. The board should hold senior management “accountable” for the effective implementation of the corporate plan.

Comment

The SR Letter establishes a clear path for examiners and companies undergoing exams regarding preparation for the LIBOR transition. Companies must devote adequate attention and resources to the effective design, implementation and execution of their LIBOR transition plans.

For more information on this topic, please contact Mark Chorazak, Reena Agrawal Sahni, Timothy Byrne or Le-el Sinai at Shearman & Sterling LLP by phone (+1 212 848 4000) or email ([email protected], [email protected], [email protected] or [email protected] com). The Shearman & Sterling LLP website can be accessed at www.shearman.com.

Caitlin Hutchinson Maddox, Partner, helped prepare this article.

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