December 19, 2019 - The regulators are coming. In summer 2019, the SEC flagged the risks around LIBOR cessation and provided guidance around managing risk for the entities it regulated. Last week, the Comptroller of the Currency (OCC) did the same for the banks it regulates. We estimate that at least 80% of LSTA financial firm members are regulated by one of these two agencies. So, if you are an OCC-regulated bank, what is that agency telling you?
The OCC’s gentle suggestions come on pages 17-18 of the OCC’s Semi- Annual Risk Perspective. Let’s start with the punch line: The OCC announced that it is “increasing oversight of this area [LIBOR cessation] through 2020 and 2021.”
What is the OCC looking for? It notes that LIBOR cessation by year-end 2021 may increase operational and other risks to industry. In particular, it suggests that an accurate inventory of balance sheet assets, liabilities and off-balance-sheet contracts may help determine risk exposure. Second, there can be compliance and reputation risks in moving customers to a new rate; risk assessment should include analysis of customer impact, repapering contracts, updating system applications, revising and testing models, and ensuring appropriate contractual fallback language and disclosure to clients. Importantly, the OCC notes that “[b]anks should seek to minimize pricing issues with observable, objective rules that are determined before Libor cessation” (emphasis added).
How do these recommendations align with efforts in the syndicated loan market? First, through the Business Loans Working Group (“BLWG”), which is co-chaired by the LSTA, the ARRC has released recommended “LIBOR fallback language for syndicated loans”. It includes an “amendment approach” (which is partially governed by observable, objective rules) and a “hardwired approach” (which is almost entirely governed by observable, objective rules). While the loan market (to date) has been universally adopting an amendment approach, the Risk Perspective’s language suggests that an “observable, objective” hardwired approach may be more attractive to the OCC. Second, the ARRC BLWG has been working on recommended conventions that could facilitate the operationalization of SOFR, and thus help update system applications. Finally, the LSTA has been developing a SOFR Concept Credit Agreement. By demonstrating how a typical LIBOR credit agreement would need to change, this work should help facilitate repapering syndicated loan contracts. The LSTA is committed to helping the market through LIBOR transition. To address member questions, we host a weekly LIBOR Q&A Call on Mondays at 3PM (ET) and encourage participants to email questions or ask them live.