Last week, a number of federal and state financial regulators issued a joint statement regarding the phaseout of the London Interbank Offered Rate (“LIBOR”), encouraging market participants to “continue to progress toward an orderly transition away from LIBOR.” They warned that a failure to properly prepare for the transition could create a number of risks, including undermining financial stability, and creating potential litigation, operational, and consumer protection issues for individual institutions. Importantly, they added that supervisory focus and review will continue to increase as the LIBOR cessation date draws near, and institutions with a comprehensive and proactive approach will be better prepared.

This announcement from the Board of Governors of the Federal Reserve, the Consumer Financial Protection Bureau, the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of the Currency, and certain state bank and credit union regulators (collectively, the “Financial Regulators”) comes just weeks before (i) one-week and 2-month USD-LIBOR settings will cease to be published, and (ii) all market participants are encouraged to cease using USD-LIBOR in any form or tenor (on December 31, 2021) in any new contracts. In preparing for this massive transition, the Financial Regulators offered the following guidance for all of their supervised institutions (meaning all banks, credit unions and other lenders):

Clarification on “new” LIBOR contracts: Any new contracts that reference LIBOR after December 31, 2021, would create safety and soundness risks, and therefore will no longer be permitted after such date. To that end, new contracts include those that:
 

• Increase LIBOR exposure for a supervised institution
• Extend the term of an existing LIBOR contract

New contracts do not include:
 

• A draw on an existing agreement that is legally enforceable (e.g., a committed credit facility)

Robust fallback terms: Any contract that references a tenor of LIBOR and that matures after the relevant LIBOR sunset date (for most contracts, this is June 30, 2023) should be modified, as needed, to account for the transition away from LIBOR. New contracts executed between now and December 31, 2021, should either reference a rate that is not based on LIBOR, or include robust LIBOR fallback terms that provide a “strong and clearly defined” alterative reference rate. This means that fallback terms that allow for the lender to use its discretion in choosing a replacement rate, or template options like the ARRC’s “amendment approach,” are no longer acceptable.

Alternative rates: Supervised institutions should do their due diligence to ensure that the alternative rate they select to replace LIBOR is appropriate for the institution’s products, risk profile, risk management capabilities, customer and funding needs, and operational capabilities. The Financial Regulators encouraged market participants to understand any fragilities associated with the alternative rate or the markets that underlie it. 

This admonition comes on the heels of a recent statement from the Board of the International Organization of Securities Commissions (“IOSCO”), in which the organization expressed concern that certain credit sensitive rates intended to replace LIBOR may actually have the same market integrity issues as LIBOR.  And while the Financial Regulators have not explicitly prohibited the use of any alternative references rates, it does appear that they will be scrutinizing their supervised institutions’ choice of LIBOR replacement rates quite closely.

Additional considerations: Supervised institutions should-

• Have or develop a transition plan to communicate with consumers, clients, and counterparties about the transition away from LIBOR
• Ensure systems and operational capabilities are updated to account for replacement rate once LIBOR is no longer viable

Questions? Michael Best’s LIBOR transition team is here to help, with market insights, customized alternative reference rate terms, and High-Volume Loan Amendment Service offerings to meet your institution’s LIBOR transition needs in the coming months.  Please contact Alec Fraser or Cheryl Isaac to get started.