In this Ropes & Gray podcast, Jason Brown and Jill Kalish Levy discuss the recent Risk Alert published by the SEC Office of Compliance and Inspections concerning the end of LIBOR, and what that Risk Alert means for market participants. Since the announcement of LIBOR's cessation, the Fed has made great strides in pushing its replacement, "SOFR," but this transition has proven to be operationally and logistically complicated. In this podcast, Jill and Jason examine these issues and how to prepare for OCIE's examinations of various registrants to assess their efforts in preparing for the discontinuation of LIBOR.
Jason Brown:Hello, and welcome to this Ropes & Gray podcast. My name is Jason Brown, and I am a partner at Ropes & Gray in our asset management practice. Joining me today is Jill Kalish Levy, who is knowledge management counsel in our finance group. In this podcast, we will be discussing the recent Risk Alert published by the SEC Office of Compliance and Inspections concerning the end of LIBOR, and what that Risk Alert means for market participants. Jill, it's nice to be speaking about LIBOR with you again. Perhaps you can share a bit of background and then we can talk more about the Alert itself.
Jill Kalish Levy: Sure. As everybody is by now aware, the UK regulatory bodies that administer LIBOR announced in the summer of 2017 that after 2021, LIBOR would no longer be available as a reference rate. Given LIBOR's troubled history, the announcement shouldn't have been a big surprise, but it still left people reeling as they began to contemplate how they would replace what is probably the most ubiquitous number in the world.
Jason Brown: And to what extent has the market recovered from that announcement and acted to address this development in the last three years?
Jill Kalish Levy: Well, a lot has happened in that time. The U.S. and UK governments initially struggled to find a reference rate that could really replace LIBOR in its current form, but they did eventually identify a replacement rate and build consensus around it. We now know that LIBOR will very likely be replaced by the Secured Overnight Funding Rate, or "SOFR" in the U.S. and the Sterling Overnight Interbank Average Rate, or "SONIA", in the UK. From the time these replacement reference rates were introduced, the goal of the Federal Reserve has been widespread adoption of SOFR in advance of LIBOR's demise so that the transition will be as easy as possible.
Jason Brown: And how has that progressed? Are we now seeing the markets begin to adopt SOFR in the place of LIBOR?
Jill Kalish Levy: Well, that's been a little complicated. It is, of course, great that the Fed made a decision and decided on SOFR, and has already done so much work towards this transition. But it must be said that replacing LIBOR has not been easy so far. While SOFR is now the presumptive replacement for LIBOR, SOFR operates very differently than LIBOR and was, to the minds of certain populations, a controversial and inconvenient choice. Many different variations of SOFR were contemplated for different asset classes.
Jason Brown: I see. And now that we know what will be on SOFR, has the rate of adoption increased, or are market constituents still struggling to make the transition?
Jill Kalish Levy: Well, SOFR was, at least initially, unpopular with certain segments of the market because of how different it is from LIBOR. But even if that were not the case, the replacement of LIBOR with any new reference rate would be a challenging thing to achieve. The process of replacing LIBOR is loaded with legal, technical and logistical issues. These issues meant that many people did not do as much as they could as quickly as they could to address LIBOR cessation within their various institutions. It took some time for companies and firms to truly start allocating resources to this issue and many people are still catching up.
Jason Brown: That makes sense. In addition to how burdensome it must be for everybody to switch over to SOFR operationally and logistically, I imagine there must also be complexities from a documentation perspective as well – is that right?
Jill Kalish Levy: That's exactly right. In addition to the lethargy around such an onerous and expensive undertaking, there were and still are certain problems with LIBOR replacement that don't have a great solution. For example, there are many instruments that have been issued that reference LIBOR but don't address a scenario in which LIBOR is no longer available. For instruments that don't contemplate these current facts and cannot be easily amended, replacing LIBOR is a confusing proposition.
Jason Brown: Has the Fed or the ARRC addressed these issues to guide the various parties?
Jill Kalish Levy: I think the Fed and the Alternative Reference Rate Committee were hoping that more of those issues would be ironed out privately between contract parties, but in many cases that has not happened. The Fed has done other things to try to push LIBOR replacement forward.
Jason Brown: Can you tell us a bit about that?
Jill Kalish Levy: Sure. Well, one thing they've done is harnessed other regulatory entities to help promulgate SOFR and encourage market participants to prepare for LIBOR to be unavailable. One example of this is SEC guidance that was issued in the summer of 2019. That guidance made clear that the SEC would be reviewing all issuers' filings for adequate disclosure and risk factors relating to the end of LIBOR. Other examples are the involvement of the Office of Comptroller of Currency and the New York Department of Financial Services, both of which each recently announced increased oversight of LIBOR transition planning. OCC has made clear that they will be working with banks to make sure banks have properly assessed their exposure to LIBOR. The DFS required all New York-based regulated financial institutions to submit fulsome LIBOR transition plans by this past February. FINRA is also involved – they're working with firms on LIBOR transition outside the purview of their usual activities. Even the Consumer Financial Protection Bureau has published guidance on managing this whole process, noting that the expected discontinuance of LIBOR can affect various consumer financial products.
Jason Brown: It seems like everybody is on the LIBOR bandwagon right now. Which brings us to the Alert – what can you share about it?
Jill Kalish Levy: On June 18, the Office of Compliance Inspections and Examinations, or OCIE, which is part of the SEC, published a Risk Alert about LIBOR Transition Preparedness. The Alert states that in coming months, OCIE will conduct examinations of various registrants to assess their efforts in preparing for the discontinuation of LIBOR. OCIE will be looking at many things, including but not limited to whether the registrant has evaluated the impact of LIBOR cessation on business activities, operations, services, customers, consumers and investors.
Jason Brown: What does this really mean for SEC registrants?
Jill Kalish Levy: Well, OCIE is going to complete thorough reviews of the plans that registered entities have formulated to address exposure to LIBOR-linked contracts, including any fallback language included in those contracts intended to address LIBOR discontinuation. They'll look at whether companies have included adequate disclosure and representations in their filings about the possible risks of LIBOR cessation, but they will also be looking at operational readiness and whether companies have prepared internally to make calculations using SOFR, even prior to LIBOR becoming unavailable. OCIE attached an Appendix to the Risk Alert to make it very clear what they might be looking at to determine whether a company is doing enough to get ready, and it's a long list. The list includes organizational documents, information about business structure, information about any group or team that has been tasked with LIBOR transition, information about any third party that the registrant might have retained to help them understand the impact of LIBOR transition, plans, matrices, timetables, and many, many other items that can help OCIE understand what the company is doing to get ready. The list of things they might look at and consider is long and wide, and makes clear that OCIE will assume broad authority in the context of these examinations to determine whether a company is doing enough to be fully prepared for the end of LIBOR.
Jason Brown: It seems like the Risk Alert is one of the most concrete tools we have seen to date that aims to really push people to address the end of LIBOR in a fulsome way within their own institutions.
Jill Kalish Levy: Yes, the message it sends is very clear. Parties have to expect that the SEC will look at essentially everything they deem relevant to assess whether a registrant is taking adequate steps to get ready for this very significant change. To the extent that anybody has not given LIBOR cessation their full attention to date, the Risk Alert is intended to change that.
Jason Brown: Thank you, Jill, for sharing these insights. We'll certainly come back and check in as the issues here develop.
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