Within the last week, both the US Securities and Exchange Commission’s (SEC) Office of Compliance Inspections and Examinations (OCIE) and the Financial Industry Regulatory Authority (FINRA) have issued their 2020 annual report or letter1 for their respective examination priorities and each included London Interbank Offered Rate (LIBOR) preparedness as a priority for examination.
The OCIE report includes the following (at p. 5):
OCIE will . . . closely track and evaluate the impact of several major risk themes affecting its registrant population, including . . . the industry’s transition away from LIBOR.
The OCIE report also includes the following (at pp.8-9; emphasis added):
OCIE’s analytic efforts and examinations remain firmly grounded in its four pillars: promoting compliance, preventing fraud, identifying and monitoring risk, and informing policy. The risk-based approach, both in selecting registrants as examination candidates and in scoping risk areas to examine, provides OCIE with greater flexibility to cover emerging and exigent risks to investors and the marketplace as they arise. For example, as our registrants and other market participants transition away from LIBOR as a widely used reference rate in a number of financial instruments to an alternative reference rate, OCIE will be reviewing firms’ preparations and disclosures regarding their readiness, particularly in relation to the transition’s effects on investors. Some registrants have already begun this effort and OCIE encourages each registrant to evaluate its organization’s and clients’ exposure to LIBOR, not just in the context of fallback language in contracts, but its use in benchmarks and indices; accounting systems; risk models; and client reporting, among other areas. Insufficient preparation could cause harm to retail investors and significant legal and compliance, economic and operational risks for registrants.
OCIE’s commentary about the LIBOR transition echoes, in part, the guidance and concerns voiced by SEC staff in a June 2019 Public Statement: https://www.sec.gov/news/public-statement/libor-transition.
The FINRA letter states:
FINRA will engage with firms—outside the examination program—to understand how the industry is preparing for LIBOR’s retirement at the end of 2021, focusing on firms’ exposure to LIBOR-linked financial products; steps firms are taking to plan for the transition away from LIBOR to alternative rates, such as the Secured Overnight Financing Rate (SOFR); and the impact of the LIBOR phase-out on customers.
Given the continued and increased focus by regulators on LIBOR transition preparation, SEC registrants and other market participants should carefully review the regulators’ statements on this topic and take timely and appropriate actions in response.
1 The OCIE report is available at: https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2020.pdf and the FINRA letter is available at: https://www.finra.org/rules-guidance/communications-firms/2020-risk-monitoring-and-examination-priorities-letter.