The Federal Housing Finance Agency ("FHFA") provided guidance to Federal Home Loan Banks ("FHLBanks") on "expectations regarding the use of alternative reference rates." In the Supervisory Letter, the FHFA Division of Bank Regulation advised FHLBanks to address whether:
- the reference rate is based on actual daily market transactions, including during times of economic turmoil;
- the reference rate sufficiently correlates with the Bank funding costs;
- the reference rate is the most robust option available for its intended purpose;
- they have all the information necessary regarding the rate's underlying transactions and methodology in order to observe its representativeness over time;
- the contract language accompanying the use of the rate is sufficiently clear to determine (i) the circumstances in which the rate will be considered unreliable or unrepresentative, (ii) the replacement rates to be used in such circumstances and (iii) the entity that will make such decisions; and
- they are able to adequately hedge for the rate in the foreseeable future and during times of market stress.
Additionally, the FHFA recommended that FHLBanks avoid (i) rates with the shortcomings that exist in the London Inter-Bank Offered Rate and other discontinued rates, or rates that will soon be discontinued, and (ii) using models that introduce unnecessary model risk. The FHFA also advised that FHLBanks must provide their Examiners-in-Charge of plans with advance notice if they intend to use an alternative reference rate that they are not already using.
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