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Federal Reserve Provides Guidance on Review of Firms' LIBOR Transition Plans
Practical Law Legal Update w-030-0896 (Approx. 5 pages)
Federal Reserve Provides Guidance on Review of Firms' LIBOR Transition Plans
by Practical Law Finance
| Published on 11 Mar 2021 • USA (National/Federal) |
The Board of Governors of the Federal Reserve System (FRB) issued a letter to supervised firms emphasizing that firms should be making progress in transitioning away from LIBOR by December 31, 2021, and that firms that are not making adequate progress may be subject to supervisory action.
On March 9, 2021, the Board of Governors of the Federal Reserve System (FRB) issued a letter to supervised firms emphasizing that:
- Firms should be making progress in transitioning away from LIBOR by December 31, 2021.
- Firms that are not making adequate progress may be subject to supervisory action.
The letter is a follow-up to the interagency statement on LIBOR transition issued November 30, 2020, in which the FRB, along with the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC), encouraged banks to transition away from reference rate US dollar LIBOR as soon as possible (see Legal Update, ICE Benchmark Administration (IBA) Announces Projected End Dates for USD LIBOR with Extension for Certain USD LIBOR Settings Until June 2023).
According to the letter, FRB examiners will be reviewing firms' LIBOR transition plans to ensure that firms are ready to stop issuing LIBOR-based contracts by December 31, 2021. The letter includes two attachments with guidance for examiners in assessing the LIBOR transition efforts:
Each of the guidance documents outlines the following six key factors of firms' transition efforts, with more detail provided in the guidance for larger firms:
- Transition planning.
- Financial exposure measurement and risk assessment.
- Operational preparedness and controls.
- Legal contract preparedness.
- Communication.
- Oversight.
The guidance documents state that the examinations should be tailored to the size and complexity of the firm's LIBOR exposures. For firms with less than $100 billion in total consolidated assets, the reviews may be smaller and more narrowly focused, while reviews of firms with $100 billion or more in total consolidated assets, which likely have significant exposure to LIBOR, will be more detailed and complex. As part of the guidance for larger banks, the FRB recommends, for example, that:
- Firms have a LIBOR transition plan that includes a governance structure with clearly defined roles as well as a projected timeline.
- Firms should accurately measure their financial exposures to LIBOR and report to the group designated to oversee the transition plan as part of their LIBOR transition plan's governance structure their exposure measurements frequently (for example, quarterly).
- Firms should be able to identify the proportion of their LIBOR exposures that will run off before the relevant tenor ceases (either December 31, 2021 or June 30, 2023).
- Firms should identify all internal and vendor-provided systems and models that use or require LIBOR as an input and have a plan to ensure transition of the operation of these systems and models ahead of the cessation of LIBOR.
- Firms' transition plans should address how the firm will determine and address the impact of LIBOR's cessation on contracts that lack adequate fallback language and will mature after the relevant tenor ceases (either December 31, 2021 or June 30, 2023), as applicable. The FRB recommends that firms have a complete plan in place about six months before the cessation date of any particular tenor.
- Firms that are major users of derivatives should consider adhering to the ISDA® 2020 IBOR Fallbacks Protocol and Supplement Number 70 to the 2006 ISDA Definitions, covering IBOR fallbacks, in order to implement adequate fallbacks for derivatives contracts (see Practice Note, Practice Point: Understanding the ISDA 2021 IBOR Fallbacks Supplement and Protocol).
- New LIBOR-based contracts entered into before December 31, 2021 should have robust fallback language that includes a clearly defined alternative reference rate once LIBOR is no longer available. Firms may use any reference rate that they determine is appropriate for their funding model and customer needs.
The letter states that firms that are not making adequate progress toward transitioning away from LIBOR pose risks to themselves and the financial system. Examiners may consider using supervisory findings and other supervisory actions if a firm is not ready to stop issuing LIBOR-based contracts by December 31, 2021.
On March 5, 2021, the ICE Benchmark Administration (IBA) and the UK Financial Conduct Authority (FCA) issued announcements confirming their intention to cease publishing all tenors of LIBOR settings and setting out the dates on which all LIBOR settings will either cease to be provided or no longer be representative. For details, see Legal Update, ICE Benchmark Administration (IBA) Issues Feedback Statement on Intention to Cease Publication of LIBOR Settings and FCA Statement on Future Cessation and Loss of Representativeness of LIBOR Benchmarks.
On March 8, 2021, the Alternative Reference Rates Committee (ARRC) issued a statement that the IBA and FCA announcements constituted a benchmark trigger event under recommended fallback language (see Legal Update, ARRC Confirms Occurrence of "Benchmark Transition Event" Under Recommended Fallback Language).
For further information on Practical Law materials on LIBOR cessation and replacement, see LIBOR Replacement Toolkit.