CFPB, federal and state bank and credit union regulators warn of increased supervisory scrutiny in joint statement on managing LIBOR transition

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The CFPB, Federal Reserve Board, FDIC NCUA, OCC, in conjunction with the state bank and state credit union regulators, jointly issued a statement on managing the transition away from LIBOR (Joint Statement).

In 2017, the United Kingdom’s Financial Conduct Authority (FCA), the regulator that oversees the panel of banks on whose submissions LIBOR is based, announced that it would discontinue LIBOR sometime after 2021.  That announcement was followed by a series of actions by federal regulators in anticipation of the discontinuation, including the issuance of a statement in July 2020 by the Federal Financial Institutions Examination Council that highlighted the financial, legal, consumer protection, and operational risks that will result from LIBOR’s discontinuation.

The Joint Statement indicates that in March 2021, the FCA announced that the one-week and two-month U.S. Dollar (USD) LIBOR settings will no longer be published after December 31, 2021 but the publication of overnight and one, three-, six-, and 12-month USD LIBOR settings will be extended through June 30, 2023.  The Joint Statement advises that this extension “is not an indication that any of the extended USD LIBOR rates will be subsequently published after June 30, 2023.”

The Joint Statement emphasizes the agencies’ expectation that supervised institutions with LIBOR exposure continue to progress toward an orderly transition away from LIBOR and, most significantly, warns that “[s]upervisory focus and review will continue to increase as the LIBOR cessation date approaches.”  It provides the following clarifications regarding new LIBOR contracts, considerations when assessing the appropriateness of alternative reference rates, and expectations for fallback language:

  • New LIBOR contracts.  The agencies view entering into new contracts, including derivatives, that use LIBOR as a reference rate after December 31, 2021 as actions that would create safety and soundness risks.  The Joint Statement clarifies that for this purpose, a new contract would include an agreement that (1) creates additional LIBOR exposure for a supervised institution, or (2) extends the term of an existing LIBOR contract.  A draw on an existing agreement that is legally enforceable would not be viewed as a new contract.  Contracts entered into on or before December 31, 2021 should either use a reference rate other than LIBOR or have fallback language providing for the use of “a strong and clearly defined alternative reference rate after LIBOR’s discontinuation.”
  • Appropriateness of alternative reference rates.  Safe and sound practices include conducting due diligence to ensure that alternative rate selections are appropriate for a supervised institution’s products, risk profile, risk management capabilities, customer and funding needs, and operational capabilities.  Due diligence includes obtaining an understanding how a reference rate is constructed and identifying any fragilities associated with the rate and the markets underlying it.
  • Fallback language.  Supervised institutions should identify all contracts that reference LIBOR, lack adequate fallback language, and will mature after the relevant reference rate ceases.  Supervised institutions, going forward, are encouraged to include fallback language in new or updated contracts that provides for “a strong and clearly defined fallback rate when the initial reference rate is discontinued.”

The Joint Statement also encourages supervised institutions to develop and implement a transition plan for communicating with consumers, clients, and counterparties, and to ensure that their systems and operational capabilities will be ready to transition to a replacement reference rate after LIBOR’s discontinuation.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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