OCIE’s Risk Alert on LIBOR Transition Preparedness

Kramer Levin Naftalis & Frankel LLP

In January 2020, the Office of Compliance Inspections and Examinations (OCIE) included London Interbank Offered Rate (LIBOR) preparedness as an examination program priority in its 2020 Examination Priorities (2020 Priorities). On June 18, OCIE released a Risk Alert (Risk Alert) to provide market participants, including SEC-registered investment advisers, broker-dealers, investment companies, municipal advisors, transfer agents and clearing agencies (registrants) with additional information about the scope and content of the examination program announced in the 2020 Priorities.

The Risk Alert highlighted that preparation for the transition away from LIBOR is essential for minimizing any potential adverse effects associated with LIBOR discontinuation. OCIE asserted that it will engage in examinations of various registrants to assess their preparedness with respect to the expected LIBOR discontinuation and transition to alternative reference rates. OCIE’s examinations may include, among others, registrants’ evaluation of the potential impact of the LIBOR transition on the registrants’ business activities, operations and services, as well as on their customers, clients and investors.

OCIE stated that it will review the registrants’ plans and steps taken for:

  • The firm’s and investor’s exposure to LIBOR-linked contracts that extend past the current expected discontinuation date, including any fallback language incorporated into these contracts
  • The firm’s operational readiness, including any enhancements or modifications to systems, controls, processes and risk or valuation models associated with the transition to a new reference rate or benchmark
  • The firm’s disclosures, representations and/or reporting to investors regarding its efforts to address LIBOR discontinuation and the adoption of alternative reference rates
  • The potential conflicts of interest associated with the LIBOR discontinuation and the adoption of alternative reference rates
  • The client’s efforts to replace LIBOR with an appropriate alternative reference rate

OCIE attached as Appendix A to the Risk Alert a sample document request list that it may use to conduct examinations of registrants regarding their LIBOR discontinuation preparedness. Although the non-exhaustive list does not constitute a safe harbor, it provides registrants with questions and tools they may use to assess and assist with their preparedness for the LIBOR discontinuation. OCIE noted that the adequacy of supervisory, compliance and other risk management systems can be determined only with reference to the profile of each specific firm as well as other facts and circumstances. Consequently, factors other than those set forth in the Risk Alert may be appropriate to consider, and some of the factors listed in the Risk Alert may not be applicable to a particular registrant’s case. OCIE’s sample document request list includes the following factors:

  1. Information regarding registrant’s organizational structure and business lines, particularly regarding the individuals, positions, departments and operations that may be impacted by discontinuation of LIBOR transition and transition to an alternative rate (LIBOR Transition).
  2. Information regarding any individuals or groups (e.g., internal committees, working groups or transition teams) assigned responsibility to oversee or manage the effects of the LIBOR Transition on the registrant, including information regarding the frequency of any meetings on this topic and whether minutes are kept.
  3. The identity of any third parties registrant has utilized or plans to utilize to assess the impact of the LIBOR Transition on the firm or its clients, customers or investors (investors).
  4. Documentation or descriptions of any analysis performed to identify contracts or obligations held and/or issued by registrant or its investors that may be affected by the LIBOR Transition and any remediation plans thereof.
  5. Documentation or descriptions of any performance composites or performance advertising that use a benchmark that could potentially be affected by the LIBOR Transition and any remediation plans thereof.
  6. Information regarding any investors whose fee structure (e.g., performance-based fees) or performance reporting (e.g., use of LIBOR-linked benchmark) could potentially be affected by the LIBOR Transition.
  7. Any written assessments, strategic plans (including remediation plans, as applicable), roadmaps, or timelines prepared by or for registrant regarding preparation for the LIBOR Transition, including the consideration of alternative reference rates.
  8. Documentation of any risk management matrices or risk inventories of registrant that reference the LIBOR Transition, including a description of any LIBOR Transition-related vulnerabilities or exposure covered by the matrix or inventory.
  9. Documentation or descriptions of any analysis performed to identify LIBOR-based risk or valuation models used by registrant, including information regarding changes that may be needed to account for a new reference rate, if any.
  10. Materials referencing the LIBOR Transition provided to registrant’s board of directors, any committee of the board of directors, any board member, the board or board member(s) of any investors, or the board, legislative body or member(s) thereof of any municipal entity or obligated person client, if applicable, or equivalent governing bodies or offices, if registrant is not organized as a corporation.
  11. Information regarding any third-party vendors registrant uses that may be impacted by the LIBOR Transition, including the services provided (e.g., back office) and how the vendor may be impacted.
  12. Information regarding any LIBOR-linked contracts or obligations that extend past the current expected discontinuation date that are held and/or issued by registrant, including the implications and impact of any incorporated fallback language.
  13. Information regarding any LIBOR-linked contracts or obligations that extend past the current expected discontinuation date that are held and/or issued by registrant’s investors, including the implications and impact of any incorporated fallback language.
  14. Information regarding any contracts or obligations held and/or issued by registrant, or its investors, that reference a rate identified as an alternative to LIBOR (e.g., SOFR).
  15. Information regarding any changes made or planned to be made to registrant’s information technology systems (e.g., accounting, investor reporting, risk, valuation or trading) to accommodate the LIBOR Transition, including any changes to accommodate new instruments/contracts and rates with features that differ from LIBOR.
  16. Disclosures provided in registrant’s filings with the Commission and/or to investors (e.g., in prospectuses) about the LIBOR Transition, including fallback language for LIBOR instruments, as applicable, during the period of January 2019 to the present.
  17. Any guidance provided by registrant to employees or supervised persons concerning recommendations to investors to purchase, sell or enter into LIBOR-linked instruments or contracts that extend past the current expected discontinuation date, reviews of portfolios containing such instruments, or the underwriting of new instruments referencing LIBOR, if applicable.
  18. Any guidance provided by registrant to employees or supervised persons regarding the provision of advice to issuers of new LIBOR-linked instruments.
  19. Any guidance provided by registrant to employees or supervised persons regarding the provision of advice to clients regarding the replacement of LIBOR in outstanding contracts or obligations with an appropriate alternative reference rate.
  20. Any implemented or planned changes to compliance procedures, controls or surveillance systems designed to monitor for LIBOR-linked instruments or contracts recommended or sold to clients.

The 2020 Priorities can be found here. The Risk Alert can be found here. On July 12, 2019, Kramer Levin issued a client alert regarding the announcement by the staffs of the SEC’s Division of Corporate Finance, Division of Investment Management, Division of Trading and Markets, and Office of the Chief Accountant addressing the discontinuance of LIBOR that can be found here.

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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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