United States: "To SOFR Or Not To SOFR?": Prudential Banking Regulators Encourage Fallback Provisions To An "Appropriate" LIBOR Replacement Rate

The Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency ("OCC"), and the Federal Deposit Insurance Corporation (collectively, the "Agencies") released an Interagency Statement on Reference Rates for Loans on November 6, 2020, in which they reiterated that they do not endorse SOFR-the Secured Overnight Financing Rate-or any other specific replacement rate for the London Interbank Offered Rate ("LIBOR"), for use in loan transactions.

The Agencies stated that a bank may use "any reference rate for its loans that the bank determines to be appropriate for its funding model and customer needs." They noted, however, that the chosen rate should be robust, and that banks should include fallback language in their loan agreements providing for the use of such chosen rate if LIBOR were to be discontinued.

Because the funding models and lending activity structures of banks vary, suitable rates may include "credit-sensitive alternatives to LIBOR."

Importantly, the Agencies encouraged immediate transition away from LIBOR and advised, "All institutions should have risk management processes in place to identify and mitigate their LIBOR transition risks that are commensurate with the size and complexity of their exposures. Examiners will not criticize banks solely for using a reference rate, including a credit sensitive rate, other than SOFR for loans."

The statement builds on the Joint Statement on Managing the LIBOR Transition issued by the Federal Financial Institutions Examination Council on July 1, 2020¹, which highlighted the financial, legal, operational, and consumer protection risks that are expected to result from LIBOR's discontinuance and encouraged supervised institutions to address associated risks, as well as OCC Bulletin 2020-68² issued on the same date, which expanded upon the FFEIC joint statement and provided related risk management guidance.

Footnotes

1. Discussed in our Perspective "US FFIEC Issues Joint Statement on Managing the LIBOR Transition."

2. Discussed in our Perspective "OCC Expands FFIEC Statement, Provides Guidance to Banks on Managing LIBOR Transition."

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