United States: The SEC Adds Its Voice To The LIBOR Chorus

In a public statement dated July 12, 2019, the Securities and Exchange Commission's ("SEC") Divisions of Corporation Finance, Investment Management and Trading and Markets, and the Office of the Chief Accountant, encouraged market participants to begin the transition away from U.S. dollar LIBOR, which is expected to cease publication in 2021.1 The SEC's public statement is significant in that it adds the voice of a non-bank regulator to the discussion on replacing LIBOR. As noted by the SEC, the upcoming LIBOR discontinuance "may present a material risk for certain market participants, including public companies, investment advisers, investment companies and broker-dealers."

Prior to the SEC's public statement, the Alternative Reference Rates Committee ("ARRC"), a group convened by the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of New York, has been the main source of guidance to market participants in the areas of loans, derivatives and floating rate notes based on U.S. dollar LIBOR. To a casual observer, it might have appeared that the concerns were being voiced mainly by banking regulators and that the potential risks relating to the cessation of U.S. dollar LIBOR were confined to the financial services industry. The Division of Corporation Finance stated that the "companies most frequently providing LIBOR transition disclosure are in the real estate, banking, and insurance industries," but also encouraged every company, if it has not done so already, to begin planning for the transition away from LIBOR.

The Division of Corporation Finance focused on disclosure of risks and events that a reasonable investor would consider important to an investment decision. Disclosure relating to the expected LIBOR discontinuance could be triggered by risk factor disclosure requirements (Item 105 of Regulation S-K and Item 3.D of Form 20-F), management's discussion and analysis (Item 303 of Regulation S-K and Item 5 of Form 20-F), board risk oversight (Item 407(h) of Regulation S-K) and the financial statements. An issuer should keep investors informed about the progress toward risk identification and mitigation, and the anticipated effects on the issuer, if material.

The Division of Trading and Markets addressed the effect that a LIBOR discontinuation would have on broker-dealers, central counterparties and exchanges, noting that these parties may:

  • issue instruments or be party to transactions, including derivative transactions, referencing LIBOR;
  • own investments that reference LIBOR or make a market in instruments that reference LIBOR;
  • have LIBOR-based hedges in place;
  • underwrite, place or advise on the issuance of instruments referencing LIBOR;
  • recommend investments in LIBOR-based securities, including to retail investors; and
  • have listing and clearing standards that do not contemplate a LIBOR replacement benchmark.

The Office of the Chief Accountant highlighted the effect that a transition away from LIBOR could have on the accounting and financial reporting for:

  • modifications of terms within debt instruments;.
  • hedging activities;
  • inputs in valuation models; and
  • potential income tax consequences.

Replacement rate neutrality. The SEC, after noting that the secured overnight financing rate ("SOFR") has been proposed as a replacement for U.S. dollar LIBOR, mentioned that some market participants are also considering other U.S. dollar reference rates for certain instruments and that it does not endorse the use of any particular reference rate. This is an interesting contrast to previous statements by the ARRC, which strongly supports the use of SOFR to replace LIBOR. The SEC also said that the Staff "is monitoring whether the adoption of a variety of replacements rates for USD LIBOR instead of the emergence of a dominant successor could limit the effectiveness of all replacement benchmarks."

Footnote

1. The Public Statement is available at: https://bit.ly/2Yy6U1E.


Originally published in REVERSEinquiries: Volume 2, Issue 7.
Click here to read the articles in this latest edition.


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