On July 1, 2020, the United States Federal Financial Institutions Examination Council (FFIEC)1 issued its Joint Statement on Managing the LIBOR Transition (FFIEC Statement), adding its voice to the global regulatory chorus2 calling for active engagement by supervised financial institutions and effective preparation for, and management of, the expected discontinuation of the London Interbank Offered Rate (LIBOR) and transition to alternative reference rates and warning of increased regulatory scrutiny regarding LIBOR transition preparedness.
The FFIEC Statement highlights the financial, legal, operational and consumer protection risks that will result from the transition from LIBOR and encourages supervised institutions to continue their efforts to prepare for this change and address its associated risks. The risks noted in the FFIEC Statement include:
- Operational difficulty in quantifying exposure;
- Financial, valuation and model risk related to reference rate transition;
- Inadequate risk management processes and controls to support transition;
- Consumer protection-related risks;
- Limited ability of third-party service providers to support operational changes; and
- Potential litigation and reputational risk arising from reference rate transition.
While the FFIEC Statement states that the FFIEC is not establishing new guidance or regulation, the FFIEC Statement then notes a number of potential preparedness and risk management actions that institutions should factor into their planning for the transition and states that the supervisory focus on evaluating institutions’ preparedness for LIBOR’s discontinuation will increase during 2020 and 2021, particularly for institutions with significant LIBOR exposure or less-developed transition processes. During regularly scheduled examinations and monitoring activities, supervisory staff will ask institutions about their planning for the LIBOR transition, including the identification of exposures, efforts to include fallback language or use alternative reference rates in new contracts, operational preparedness and consumer protection considerations. The FFIEC states that at institutions with exposures to LIBOR-indexed instruments, supervisory staff will engage in discussions about transition efforts, including:
- Identification and quantification of LIBOR exposure across product categories and lines of business;
- Risk assessment of LIBOR exposures, which may include scenario testing, legal review and other analysis;
- Transition plans with milestones and key completion dates, addressing areas such as:
- Strategies to inventory, analyze and assess risk posed by existing contracts;
- Strategies to identify replacement rates, modify spreads and revise existing contracts, as necessary;
- Strategies to address third-party risk management;
- Potential impact to the institution’s customers;
- Communication plans for engaging with customers and other stakeholders; and
- Plans to identify, monitor and resolve system and other operational constraints;
- Management’s assessment of revisions that may be necessary to update the institution’s policies, processes and internal control systems;
- Responsibility for LIBOR transition oversight (to a committee, team or officer); and
- Progress reporting to a supervised institution’s board of directors and senior management on the LIBOR transition plan.
As the December 31, 2021, deadline for the cessation of LIBOR gets closer, regulatory warnings like the FFIEC Statement are likely to increase in number and urgency.
1 The FFIEC is composed of the following: a member of the Board of Governors of the Federal Reserve System (FRB), appointed by the chairman of the FRB; the director of the Bureau of Consumer Financial Protection; the chairman of the Federal Deposit Insurance Corporation (FDIC); the chairman of the National Credit Union Administration (NCUA); the comptroller of the Currency; and the chairman of the State Liaison Committee.
2 See our prior related Perspectives at: https://www.mayerbrown.com/en/perspectives-events/publications/2020/06/secs-ocie-to-begin-libor-preparedness-exams; https://www.mayerbrown.com/en/perspectives-events/publications/2020/06/uk-parliamentary-statement-affirms-urgent-need-to-transition-from-libor-and-previews-proposed-legislation-to-extend-regulatory-powers-of-the-fca-to-manage-transition; https://www.mayerbrown.com/en/perspectives-events/publications/2020/02/bank-of-england-turns-up-heat-on-libor-transition-and-raises-prospect-of-higher-collateral-discounts-for-secured-borrowings; https://www.mayerbrown.com/en/perspectives-events/publications/2020/01/uk-regulators-declare-2020-as-key-year-for-libor-transition-and-propose-milestones-for-transition and https://www.mayerbrown.com/en/perspectives-events/publications/2020/01/more-us-regulators-make-libor-transition-preparedness-an-examination-priority.