Part two of the series on the LIBOR phase out offers guidelines to shareholders on preparing for a transition to a new reference interest rate.
November 2018 - In July 2017, the United Kingdom’s Financial Conduct Authority, the regulatory body that oversees the London Interbank Offered Rate (LIBOR), announced that it will phase out its support of LIBOR by the end of 2021. To prepare for this phase out in the United States, the Federal Reserve convened the Alternative Reference Rate Committee (ARRC) to identify an alternative to LIBOR and establish a transition plan. The ARRC has selected the Secured Overnight Financing Rate (SOFR) as the alterative reference rate for U.S. dollar LIBOR.
Recognizing the importance of this transition, FHLBank Atlanta and the FHLBank System have been working with the industry to prepare for the shift to SOFR. The FHLBanks, including FHLBank Atlanta, are members of the ARRC and three ARRC subcommittees. The Bank also is actively engaged with the International Swaps and Derivatives Association working groups. Within its own business, FHLBank Atlanta has established a multi-year plan to help facilitate the transition to SOFR.
As a partner and trusted advisor to its shareholders, the Bank is recommending that all shareholder institutions also begin taking steps now to develop their own multi-year plans for the phase out of LIBOR and transition to SOFR. The following information outlines some key steps that the Bank believes can help shareholders plan effectively. Shareholders should also consider their own financial positions related to LIBOR and consult with their legal, accounting, and financial advisors when developing a plan.
A Transition Plan Framework
Create a team to oversee the transition
Convene a structured team led by a senior executive and comprising representatives from treasury, loan operations, accounting, legal, information technology, risk management, communications, and others as needed to develop a transition plan, oversee its execution, and report regularly to the board of directors.
Inventory existing LIBOR transactions
Quantify all financial exposure to LIBOR and estimate the impact that a LIBOR phase out may have on hedge effectiveness, interest-rate risk, basis risk, and valuations.
Evaluate existing fallback provisions in legacy transactions
Review legacy LIBOR contracts that extend beyond 2021 to determine if current fallback language is adequate to provide a smooth transition to another reference rate. A primary consideration will be the calculation of interest in adjustable-rate instruments in the absence of LIBOR. Amend contract language for those agreements as needed, in compliance with banking, securities, and consumer protection laws. In addition, determine if changes to contracts require consent of various parties named in the agreements.
Develop language for LIBOR transactions going forward
In addition to addressing fallback language in legacy contracts, develop fallback language for new transactions going forward, providing for a smooth transition to a new reference rate. Again, prepare this language for compliance with banking, securities, and consumer protection laws.
Review accounting, tax, and systems implications
Assess changes to systems, models, and other operational processes that will be triggered by the LIBOR phase out. Accounting systems, loan systems, pricing models, risk models, and other management information systems will likely require changes.
Mitigate risk of disputes and create mechanisms for handling disputes
When amending contract language or developing language for new transactions, maintain an eye on mitigating risks of disputes with borrowers or other parties to the financial contract. Create procedures and mechanisms to handle any disputes that may arise.
Develop a communications plan
Determine how to communicate changes to customers and other relevant parties.
Stay informed of industry developments and best practices
Create processes to stay up to date on developments in the industry on the LIBOR phase out and transition to SOFR, and take advantage of industry best practices around contract language and operational processes as they become available.
The exact timeline for implementing the alternative reference rate will of course depend on market and industry developments. The most critical action today is to begin planning with the understanding that plans will need to be revisited regularly and adapted as developments occur. FHLBank Atlanta is prepared to serve as a resource as shareholders develop and refine transition plans over the next few years.