October 20, 2021 - by Meredith Coffey. Both the SEC (though Gary Gensler’s pronouncements) and the Federal Reserve (through Randal Quarles’s speeches) have made their positions clear on LIBOR transition. (For the record, Mr. Gensler is not a fan of credit sensitive rates (“CSRs”), whereas Mr. Quarles has acknowledged that banks can use them for traditional lending products as long as the rates’ fragilities are understood and fallbacks are robust.) To date, though, the OCC has been quieter. Perhaps no more. Last week, the OCC released its 2022 Supervision Operating Plan. This week, it published “LIBOR Transition: Updated Self-Assessment Tool for Banks.” Next week, Acting Comptroller Michael Hsu will speak at the ARRC’s Sixth SOFR Symposium, discussing “the importance of maintaining trust in the banking system during the transition from LIBOR to replacement rates.” We dissect the recent statements below and will recap Mr. Hsu’s speech when it happens.
Last Friday, the OCC announced its upcoming supervisions and objectives – and LIBOR transition made the list. Specifically, “[e]xaminers should evaluate each bank’s implementation and execution of alternative reference rates given the December 30, 2021, cessation of LIBOR. Banks should fully understand all their exposures and be nearly complete with remediation efforts. Examiners should evaluate operational, reputation, and consumer impact assessments and change management related to an alternative index for pricing loans, deposits, and other products and services.”
This week, the OCC clarified what it may be looking for in “LIBOR Transition: Updated Self-Assessment Tool for Banks.” First, the OCC spent several paragraphs discussing IOSCO statements around compliance, noting that “IOSCO cited concern that some of LIBOR’s shortcomings may be replicated through the use of credit sensitive rates that lack sufficient underlying transaction volumes. The OCC shares those concerns.” Therefore, “[w]hile banks may use any replacement rate they determine to be appropriate for their funding model and customer needs, OCC supervisory efforts will initially focus on non-SOFR rates.” It may be worth re-reading those two quotes.
The self-assessment tool itself contains more than 30 questions, including 10 questions and sub-questions on replacement rates. The OCC specifically drew attention to five points (which we reproduce in their entirety in their own words) when assessing a replacement rate:
- the rate always reflects competitive forces of supply and demand and is anchored by a sufficient number of observable arm’s-length transactions, during all market conditions including periods of stress.
- the rate’s underlying historical data are extensive, spanning a variety of economic conditions.
- the rate’s administrator maintains durable methodology and governance processes to ensure the quality and integrity of the benchmark through periods of market stress.
- the rate’s transparency provides market participants the ability to understand the methodology, permitting them to independently substantiate the rates published.
- the market for financial instruments that use the rate is sufficiently liquid to allow for the effective management of market risk.
Following these missives, the Comptroller likely will speak directly on these issues at the ARRC’s Sixth SOFR Symposium on Tuesday, October 26th. We will parse that speech as well.