As noted in previous LIBOR Transition posts, the availability of LIBOR as a reference rate is not guaranteed beyond the end of 2021. On July 1, 2020, the Federal Financial Institutions Examination Council (FFIEC), which consists of US federal and state banking regulators and the Consumer Financial Protection Bureau, issued a Joint Statement highlighting the various risks arising that banks need to take into consideration while working on their respective LIBOR transition plans. Thorough planning now is key.
Banks are expected to have risk-based processes in order to identify and mitigate the risks their respective institutions face in planning for the discontinuance of LIBOR as a reference rate. Large complex banks likely will have many commercial and consumer financial transaction arrangements to parse through in their review of LIBOR-affected transactions. Smaller banks also may have exposure to LIBOR transition risk if LIBOR is used as a reference rate in their contracts with consumers, such as retail mortgages and credit cards.
The Joint Statement pointed out potential risks for the transition and highlighted several LIBOR transition risks of interest to the banking regulators:
Effective assessment of LIBOR Risk Exposure: Banks need to identify and quantify their LIBOR exposures in order to better understand the risks of the discontinuance of LIBOR and to plan how to communicate with their counterparties and customers about a need to amend agreements.
Fallback language in contracts: Banks need to review their agreements that reference LIBOR to see if there is fallback language that would be able to address the permanent discontinuance of LIBOR as a reference rate (as opposed to a temporary unavailability of a particular reference rate). Unclear language could lead to legal and safety and soundness risk. New contracts should be clear about an alternative rate determination process once use of LIBOR ends. The FFIEC in the Joint Statement urges banks to consider adopting the protocol for fallback language being developed by the International Swaps and Derivatives Association (ISDA) for ISDA contracts.
Consumer Impact: Banks will have to prepare notices to consumers about upcoming changes if they use LIBOR as a reference rate in their consumer contracts. Banks also should note which consumer contracts require advance notice of a change in reference rate, so they can ensure that consumer notices are sent out in a timely manner.
Third party service providers: Banks need to ensure third party service providers have their own LIBOR transition plans in advance to address their own risks involved in the transition, and to mitigate any risks that the banks may face from those service providers if they are not prepared for the transition. Service providers need to have effective plans in place to adjust their systems and processes accordingly in order to incorporate the alternative reference rate when processing transactions for banks or providing valuation/prices services to them.
Supervisory activities: Banking supervisors are reviewing, and will continue reviewing, banks’ plans for the LIBOR transition. Among other issues, banking supervisors will expect that each bank:
- will have identified and quantified its LIBOR exposure across product and business lines;
- conducted a risk assessment of such exposure;
- developed and are implementing transition plans with milestones and specific completion dates for such tasks as identifying the need to revise certain contracts and to communicate with customers;
- assessed the need for revisions in the bank’s own policies, procedures and internal controls due to the LIBOR transition;
- identified those persons at the bank who are responsible for oversight of the transition; and
- regularly updates its board of directors on the bank’s LIBOR transition efforts.
“The LIBOR Transition” is a periodic series of updates discussing reference interbank offering rates, such as LIBOR, and the challenges involved in navigating a successful transition from their use as reference rates of choice in the market. Norton Rose Fulbright has assembled a group of its lawyers from around the globe to stay on top of these issues and assist clients in the transition to new reference rates. More information can be found on our Norton Rose Fulbright web site.