Start Planning and Start Disclosing: The SEC Releases Statement Regarding LIBOR Transition
The United States Securities and Exchange Commission (the “SEC”) released a statement on Friday, July 12, 2019 notifying companies that the expected discontinuation of, or transition from, the London Interbank Offered Rate (“LIBOR”) at the end of 2021 should be addressed by companies as soon as possible and that companies must be proactive in assessing the effects of such a discontinuation of, or transition from, LIBOR as the de facto reference rate on existing company contracts, new company contracts, and any general perceived risks to the company.
The SEC will actively monitor company responses and public reporting companies must now consider the effects of the discontinuation of, or transition from, LIBOR on their(i) risk factors, (ii) management’s discussion and analysis (“MD&A”), (iii) board risk oversight and (iv) financial statements, and, accordingly, address the discontinuation of, or transition from, LIBOR if deemed relevant and appropriate in (i) through (iv) above. Companies should consider disclosing the status of efforts-to-date, significant matters yet to be addressed and material exposures even in instances where the company does not know or cannot yet know the expected impact of the discontinuation or transition from LIBOR. Companies should also consider disclosing any information that helps “investors to see this issue through the eyes of management,” which could include qualitative disclosures and, where material, quantitative disclosures, such as the notional value of contracts referencing LIBOR and extending past 2021.
1. What is LIBOR
Since the 1980s, LIBOR has been one of the most commonly used interest rate benchmarks globally. LIBOR is particularly important in the context of legal documentation as it is used as the reference rate for contracts in a variety of ways (including corporate and municipal bonds and loans, floating rate mortgages, asset-backed securities, consumer loans, and interest rate swaps and other derivatives). In determining LIBOR, a collective of financial institutions each provide a confidential response to the benchmark administrator regarding the rate at which each financial institution believes it would be able to obtain wholesale, unsecured funding for certain preset periods, or “tenors” (e.g., three (3)-months), in particular currencies from one another. From these confidential responses, an average rate is generated for seven (7) tenors in five (5) different currencies and these thirty-five (35) rates are published each business day in London.
2. The LIBOR Scandal
Given the inherent subjectivity in the calculation of LIBOR (i.e., what does the financial institution think the rate would be), a potential for manipulation existed and, in 2012, it was discovered that certain of the participating financial institutions were reporting falsified interest rates to benefit their respective institutions (and others) for an indeterminate number of years. In response, criminal charges were filed, significant fines were levied and the United Kingdom’s Financial Conduct Authority (the “FCA”) revoked the British Bankers Association’s administration of LIBOR. The FCA conferred oversight of LIBOR with a different benchmark administrator, but has since noted that it will only commit to supporting LIBOR until the end of 2021. After 2021, the FCA, as regulator of LIBOR, will not compel the participating financial institutions to continue submitting confidential responses regarding interest rates and it is expected that these financial institutions will discontinue doing so, resulting in either the cessation of publication of LIBOR altogether or a degradation in the indicative nature of the rate to the extent that it is no longer representative of market conditions (i.e., the fewer responses submitted, the less useful LIBOR would be as a benchmark reference rate). The potential disruption (and uncertainty) has led regulators and market participants to urge the implementation of alternative reference rates as soon as possible.
3. The SEC Releases Statement on LIBOR Transition
The SEC released a statement regarding the LIBOR transition on Friday, July 12, 2019, acknowledging that the “expected discontinuation
of LIBOR could have a significant impact on the financial markets and may present a material risk for certain market participants . . .” Because of this, the SEC warns companies that these risks will be exacerbated if their
efforts to transition from LIBOR to applicable alternative reference rates are not completed in a timely manner. The SEC therefore will be actively monitoring the extent to which companies are identifying and addressing the risks
presented by the LIBOR discontinuation or transition, which includes:
- Existing Contracts– companies should be working to identify contracts extending beyond 2021 which reference LIBOR to determine the impact of a discontinuation of, or transition from, LIBOR and assessing whether interest rate provisions contemplate discontinuation of, or transition from, LIBOR in a determinable way to avoid uncertainty or disagreement with the counterparty;
- New Contracts– companies should be considering the LIBOR discontinuation or transition when entering into new contracts which reference LIBOR, including whether to do so, and should seek to either (i) implement specified alternative reference rates (e.g., in the United States, the Alternative Reference Rates Committee, a group convened by the Federal Reserve Board and the Federal Reserve Bank of New York identified the Secured Overnight Financing Rate (more commonly known as “SOFR”) as its preferred alternative rate to USD LIBOR) or (ii) introduce appropriate fallback language if the companies decide to reference LIBOR; and
- Other Business Risks– companies should be working to identify all other risks arising from the discontinuation of, or transition from, LIBOR to a different alternative reference rate, which could involve the formation of a task force to assess the various potential impacts.
The SEC’s Division of Corporation Finance released its division specific guidance with the statement and stressed that the federal securities laws are designed to elicit disclosure and the potential discontinuation of, or transition from, LIBOR, which may require disclosure in companies’ risk factors, MD&A, board risk oversight, and financial statements in an effort to keep investors informed about the progress toward risk identification and mitigation, and any anticipated impacts on the companies
Potential disclosures regarding the LIBOR discontinuation or transition may span several reporting periods; however, even where the company does not know or cannot yet reasonably estimate the expected impact, it should consider disclosing that fact. Any disclosure permitting investors to see “through the eyes of management” is beneficial and may involve disclosing information being used by management and the board in assessing and monitoring the LIBOR transition to an alternative reference rate, which could include qualitative disclosures and, when material, quantitative disclosures, such as the notional value of contracts referencing LIBOR and extending past 2021.