The New York State Department of Financial Services (DFS) is requiring its regulated banks and nondepository financial institutions, insurance companies and pension plans to submit a written response describing the institution's plan to address the risks posed to it by the likely end of LIBOR. The response must be submitted to the DFS by February 7, 2020—less than five weeks from today. Specifically, on December 23, 2019, the DFS issued an industry letter directing DFS-regulated institutions to submit responses describing each institution's plans to address its LIBOR cessation and transition risk, detailing aspects from operational readiness to consumer and counterparty communication to corporate governance.1
Although regulatory agencies and policymaking organizations have increased their guidance and regulatory oversight on the cessation of LIBOR (which is expected to occur by the end of 2021) and transition to an alternative reference rate,2 the DFS is the first banking agency in the United States to impose an industry-wide requirement of written submissions demonstrating their regulated institutions' efforts in this area. Regulators in other states and countries may follow suit.
What is required?
The DFS stated that the industry letter was issued "to seek assurance that regulated institutions' boards of directors, or the equivalent governing authorities, and senior management fully understand and have assessed the risks associated with LIBOR cessation, have developed an appropriate plan to manage them and have initiated actions to facilitate transition." To do so, the DFS instructs institutions to address the following components:
- Programs that would identify, measure, monitor and manage all financial and non-financial risks of transition;
- Processes for analyzing and assessing alternative rates, and the potential associated benefits and risks of such rates both for the institution and its customers and counterparties;
- Processes for communications with customers and counterparties;
- A process and plan for operational readiness, including related accounting, tax and reporting aspects of such transition; and
- The governance framework, including oversight by the board of directors, or the equivalent governing authority, of the regulated institutions.
What institutions are covered?
The industry letter states ambiguously that all "regulated institutions" are required to submit LIBOR plans, with no definition of the scope of such term beyond providing designated email addresses for depository and nondepository institutions, insurers, and pension funds to direct their submissions. Whether the requirement is limited to institutions licensed by the DFS (i.e., NY state-chartered commercial banks, savings banks and savings and loans or foreign bank branches licensed under New York Banking Law) or applies more broadly to institutions chartered outside of New York but that have a New York presence (i.e., out-of-state state-chartered banks with New York branches) is unclear. We presume due to federal preemption that federally chartered New York branches, national banks and federal savings associations are not required to submit LIBOR plans to the DFS.
The requirement to submit a written LIBOR plan to the DFS also applies to insurance companies, nondepository institutions, money transmitters, mortgage lenders, licensed lenders, and pension plans that are regulated by DFS.
Considerations for developing LIBOR plans
The DFS's call for written plans accelerates financial institutions' efforts to assess and manage the risks presented by the likely cessation of LIBOR. Among other things, consideration should be given to:
- new and portfolio loans, lines of credit, notes, bonds, and other financing arrangements that use LIBOR as a benchmark rate;
- hedging transactions, swaps and other derivatives;
- alternative and replacement benchmark rates and how their spread, risk and term characteristics differ from LIBOR;
- the process for customer and counterparty consent to replacement benchmark rates; and
- potential asset and liability mismatches and rate divergence across a range of interest rate and market environments, and the resulting liquidity and balance sheet impacts.
Given that submissions are due in the first week of February, institutions must quickly assemble plans describing the efforts made to date, the involvement and understanding of boards of directors or their equivalent governing authorities, and the plans for addressing each of the areas outlined in the industry letter. Information in the submission should be coordinated with any other LIBOR-related disclosure the institution intends to make; for example, in reports to the Securities and Exchange Commission or other regulators.
Financial institutions that may be required to submit LIBOR plans are encouraged to contact any of the authors or your Arnold & Porter contact. The firm's LIBOR working group would be pleased to assist with any questions you may have about the likely cessation of LIBOR, transition to an alternative reference rate, liability and litigation considerations, the range of related adverse effects of such transition, and proper governance processes to address and monitor the transition.
1 Industry Letter: Request for Assurance of Preparedness for LIBOR Transition.
2 See, e.g., Statement Requesting Public Comment on a Proposed Publication of SOFR Averages and a SOFR Index (Nov. 4, 2019); OCC Semiannual Risk Perspective for Fall 2019 (Dec. 9, 2019); Reforming major interest rate benchmarks (Dec. 18, 2019).
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