United States: US FRB Issues Examiner Guidance For Assessing LIBOR Transition Progress

On March 9, 2021, the US Board of Governors of the Federal Reserve System ("FRB") issued SR 21-7, Assessing Supervised Institutions' Plans to Transition Away from the Use of the LIBOR, providing guidance to its bank examiners on how to assess the progress of supervised institutions in preparing to transition away from U.S. dollar (USD) LIBOR as a reference rate.¹ This guidance is intended to complement the Interagency Statement on LIBOR Transition that FRB issued in November 2020, which encouraged supervised firms to cease entering into new contracts that reference LIBOR as soon as practicable and noted that entering into such contracts after December 31, 2020, would create safety and soundness risks.

The new examiner guidance consists of two sets of considerations: one set that applies to supervised institutions with $100 billion or more in total consolidated assets and a separate set that applies to supervised institutions with less than $100 billion in total consolidated assets, respectively.²

The guidance for examiners at larger institutions describes how they should assess the preparations the institution has made in the following six areas:

1. Transition plan: The institution should have a LIBOR transition plan that includes a governance structure that clearly defines roles and responsibilities needed to execute the plan and a project roadmap with defined timelines and milestones.
2. Financial exposure measurement and risk assessment: The institution should accurately measure its financial exposures to LIBOR. Exposure measurement should include any financial product that references LIBOR and may include, but is not limited to, investments, derivatives, and loans.
3. Operational preparedness and risk control: The institution should identify all internal and vendor-provided systems and models that use or require LIBOR as an input and make necessary adjustments to provide smooth operation of those systems and models ahead of the cessation of LIBOR.
4. Legal contract preparedness: The institution should identify all contracts that reference LIBOR and refrain from entering into contracts without fallback language.
5. Communication: The institution should communicate to its counterparties, clients, consumers, and internal stakeholders about LIBOR transition. The institution should ensure compliance with requirements of the Truth in Lending Act and other applicable laws and regulations, and with the prohibition on engaging in Unfair or Deceptive Acts or Practices.
6. Oversight: The group designated to oversee the transition plan should ensure timely updates to senior management and the board of directors.

The guidance for examiners details expectations for each of the six areas that examiners will use to assess the progress institutions have made. If assessments suggest an institution is lagging in its LIBOR preparedness or may not be able to address its exposures in a timely manner, examiners should plan to conduct, or request that the primary supervisor conduct, additional targeted reviews of the institution before the end of 2021.

The guidance for examiners at smaller institutions addresses the same six areas, but in less prescriptive detail and in a manner that is tailored to the typical size and complexity of these institutions (e.g., updates to senior management of small institutions vs. updates to the boards of directors of larger institutions). It omits the language on conducting re-reviews, which generally is consistent with the more modest LIBOR exposures of institutions in this category.

Both sets of guidance reiterate that an institution may use any reference rate for its loans that the institution determines to be appropriate for its funding model and customer needs. They further clarify that fallback language may identify a clear mechanism for selecting an alternative rate if the parties believe that an appropriate alternative rate is not currently available. This clarification appears to address concerns regarding references in fallbacks to Term SOFR, which is not currently available.

Institutions supervised by FRB should consider the examiner guidance in their LIBOR transition activities. In publicly releasing the guidance, FRB has provided an updated roadmap of its expectations for supervised institutions and we expect this to be a significant area of focus for examiners at institutions with significant exposures linked to LIBOR. Further, even institutions that are not supervised by FRB may wish to consider the guidance as a structure for demonstrating to their examiners that they are making sufficient progress towards mitigating LIBOR risk.

Footnotes

1. FRB supervises bank and savings and loan holding companies, state member banks, and US branches and agencies of foreign banks.

2. The guidance states that the size of an foreign banking organization is measured based on its consolidated US assets.