ARRC ANNOUNCES BEST PRACTICES FOR COMPLETING TRANSITION FROM LIBOR

On May 27, 2020, the Alternative Reference Rates Committee (ARRC) published best practices for completing the financial industry’s transition away from U.S. dollar (USD) LIBOR.^[1] With 19 months remaining before the anticipated cessation of USD LIBOR at the end of 2021, the ARRC’s recommendations should provide market participants with further guidance as they continue to prepare for the transition.

Background

Since 2016,^[2] the ARRC has been conducting research and analysis in an effort to prepare the financial industry for the likely cessation of USD LIBOR. In doing so, the ARRC has, among other things, (1) published a Paced Transition Plan^[3] that outlines a number of key steps that should be taken to restructure cash products that reference USD LIBOR; (2) recommended the Secured Overnight Financing Rate (SOFR)^[4] as the alternative reference rate to USD LIBOR; (3) proposed a New York state legislative solution^[5] for amending legacy contracts that reference USD LIBOR but lack fallback language; and (4) recommended a spread-adjustment methodology^[6] to minimize changes in value that result from switching reference rates.

Because USD LIBOR’s cessation will impact a wide array of cash products, the ARRC also established working groups to obtain input on how best to transition those products away from USD LIBOR. After issuing several consultations and releasing its 2020 Objectives^[7] to set product-specific transition priorities, the ARRC finalized the best practices discussed below.

As recommendations, the guidelines are not considered binding rules or regulatory guidance, and it is up to market participants to determine to what extent they wish to adopt and apply them, taking into consideration the size and complexity of their activities and institutions, their engagement in relevant transactions and applicable supervisory and regulatory policy.

USD LIBOR Transition Best Practices: Timing, Internal Programs and Awareness

As an initial matter, the ARRC’s best practices are based on four transition preparation goals:

• New cash products that reference USD LIBOR should include ARRC-recommended, or substantially similar, fallback language as soon as possible.
• Third-party technology and operations vendors should complete all necessary enhancements to their systems to support SOFR by the end of 2020.
• New use of USD LIBOR should stop, with specific timing dependent on the circumstances of a particular cash market.
• Contracts specifying that a party will have discretion to select a replacement rate for USD LIBOR should require that party to disclose its selected replacement rate to relevant parties no later than six months before the implementation date of such rate.

Accordingly, the ARRC has recommended three best practices to achieve these goals:

• taking active steps to meet the ARRC’s recommended transition milestones set out below;
• instituting clear internal programs to prepare for the transition and assess USD LIBOR exposure; and
• incorporating further ARRC recommendations and maintaining an ongoing dialogue with key stakeholders to promote awareness of the transition and preparedness.

Transition Milestones

The first best practice is to adhere to ARRC-recommended transition milestones. As illustrated, the ARRC has recommended transition milestones for floating rate notes (FRNs), business loans, consumer loans, securitizations and derivatives with respect to fallback language implementation, operational readiness, cessation of the continued use of USD LIBOR in new contracts and selection of anticipated fallback rates.

Internal Risk Management and Assessment Programs

The second best practice is to create internal risk management and assessment programs that manage and reduce exposure to risks the transition may pose. These programs should, among other things:

• provide a governance framework with accountable senior executives to oversee a firm’s enterprise-wide USD LIBOR-transition plans;
• evaluate and mitigate risks and give heightened consideration to unique product and client exposures;
• develop a strategy for redesigning or reorganizing portfolios that contain USD LIBOR-based products;
• identify and address financial and non-financial risks arising from a transition to SOFR via the implementation of fallbacks; and
• determine accounting, regulatory and tax reporting considerations.

Transition Awareness

The third and final best practice is to stay aware of material updates to ARRC recommendations and product-specific conventions. In doing so, market participants should engage with their constituents and other key stakeholders to foster mutual awareness and preparedness. The ARRC also notes that it has provided a number of tools, conventions and principles to assist with this.

Conclusion

The ARRC’s best practices should provide guidance as the industry continues to prepare to transition away from USD LIBOR to SOFR. The ARRC will continue to publish information relevant to the USD LIBOR transition as the transition progresses.