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SEC Staff Discusses Key Considerations on LIBOR Transition

[1]This statement is being issued to remind investment professionals of their obligations when recommending LIBOR-linked securities and to remind companies and issuers of asset-backed securities of their disclosure obligations related to the LIBOR transition.[2]  This statement follows previous staff statements addressing various aspects of the forthcoming LIBOR transition.[3]

In light of the now-certain transition away from LIBOR as a reference rate for a number of different types of investments, including securities, investment professionals should be mindful of their obligations when recommending LIBOR-linked securities (defined for purposes of this statement as any security that uses LIBOR as a benchmark) and, as applicable, investment strategy recommendations involving other LIBOR-linked investments such as interest rate swaps, municipal securities, or securitizations.[4]  As discussed in greater detail below, when recommending LIBOR-linked securities or, as applicable, an investment strategy involving LIBOR-linked investments to retail customers and clients, broker-dealers should consider the best interest standard under Regulation Best Interest and investment advisers should consider their fiduciary obligations.[5]  This staff statement also includes considerations for underwriters of primary offerings of municipal securities, as well as for broker-dealers making recommendations of municipal securities.

In addition, this staff statement briefly addresses the following additional issues that market participants should consider related to the LIBOR transition: applicable disclosure obligations with respect to the transition away from LIBOR; the likely impact that the LIBOR transition will have on valuation measurements using LIBOR as an input, including those valuations determined by investment companies; and operational complexities that the LIBOR transition is likely to introduce, which may require significant IT system changes.

Background and General Considerations for Market Participants

LIBOR is an indicative measure of the average interest rate at which major global banks can borrow from one another.  LIBOR is quoted in multiple currencies and multiple terms, or “maturities,” using data reported by private-sector banks.[6]  LIBOR is used extensively in the U.S. and globally as a “benchmark” or “reference rate” for various types of investments, including but not limited to derivatives contracts; floating-rate notes; municipal securities; and tranches of securitizations, including collateralized loan obligations.  In addition, some mutual funds and exchange-traded funds (“ETFs”) invest in LIBOR-linked securities and other investments.[7]  Historically, these investments paid an interest rate based on, or their performance was otherwise tied to, LIBOR on the assumption that LIBOR’s fluctuating rate would be published regularly.

However, on March 5, 2021, LIBOR’s regulator, the Financial Conduct Authority, and administrator, ICE Benchmark Administration, Limited, announced that the publication of the one-week and two-month USD LIBOR maturities and non-USD LIBOR maturities will cease immediately after December 31, 2021, with the remaining USD LIBOR maturities ceasing immediately after June 30, 2023.[8]  In the U.S., the Alternative Rates Reference Committee (the “ARRC”), a group of market participants convened in 2014 to help ensure a successful transition away from USD LIBOR,[9] has identified the Secured Overnight Financing Rate (“SOFR”) as its preferred alternative rate.[10]  SOFR is a measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities, and is based on directly observable U.S. Treasury-backed repurchase transactions.  Liquidity in SOFR-linked products has increased significantly this year after the implementation of the SOFR First best practice as recommended by the Market Risk Advisory Committee of the Commodity Futures Trading Commission (“CFTC”).[11]  In addition, for contracts that are governed by New York state law, recent New York state legislation effectively codified the use of SOFR as the alternative in the absence of another chosen replacement rate.[12]

Issuance or transaction documents for certain LIBOR-linked securities might not contain “fallback language” (i.e., language intended to provide an alternative reference rate or otherwise address a permanent cessation of LIBOR), or such language may not be robust.  If the transaction documents for these securities contain language contemplating only a temporary cessation of LIBOR, or no fallback language at all, the operation of those securities and their expected returns will likely experience material changes when the rate is discontinued.[13]

Newer issuances of LIBOR-linked securities are more likely to contain fallback language contemplating either a temporary or permanent discontinuation of LIBOR.  The ARRC has published recommended fallback language for new issuances of a variety of debt instruments.[14]  Such fallback language seeks to provide interest rate provisions that will function upon discontinuation of LIBOR and promotes consistency in defining key terms such as benchmark transition events, benchmark replacement, and benchmark replacement adjustments.[15]  However, while the ARRC has published recommended language, U.S. issuers are not obligated to include any particular fallback language in transaction documents for new issuances of LIBOR-linked securities.[16]  Additionally, because no replacement rate is a perfect match for LIBOR, even when the transaction documents contain robust fallback language, the value of LIBOR-linked securities—and consequently their potential returns—may experience material changes upon LIBOR’s discontinuation.

Valuation measurements that use LIBOR as an input are also likely to be impacted in a variety of ways by the transition to an alternative reference rate.  First, LIBOR reflects perceived bank credit risk, while SOFR does not.  Second, each alternative reference rate may differ in currency, maturity, and basis.  Third, while the ARRC has recommended forward-looking SOFR Term Rates,[17] credit agreements using alternative reference rates like SOFR may be drafted such that market participants will not know an investment’s overall interest rate until near the end of an investment period.[18]  By contrast, when LIBOR is used the interest rate is known at the beginning of the period.  Finally, there may be changes in market liquidity and trading volumes during the transition both in the LIBOR market and with investments tied to alternative reference rates.

In addition to carefully considering legal obligations with respect to LIBOR-linked security and strategy recommendations, firms that have a duty to monitor existing holdings should also consider, where relevant, the effect of LIBOR’s expected discontinuation on customers or clients with existing holdings of securities or other investments that are linked to LIBOR.[19]  Among other things, these broker-dealers and investment advisers should consider whether those investments or related contracts have robust fallback language providing for an alternative rate when LIBOR is no longer published or ceases to be representative of its underlying market.  Where fallback language references an alternative rate, broker-dealers and investment advisers should consider whether that alternative rate has economic differences that could cause the investments to depart from their customers’ or clients’ strategy or risk tolerance.

Finally, the transition away from LIBOR also introduces operational complexities that may require market participants to make significant changes to their IT systems or operational processes, including enhancements or modifications to systems, controls, procedures, and risk or valuation models associated with the transition to a new reference rate or benchmark.[20]  Market participants should consider how to handle income accrual and payment calculations for any investments tied to such alternative rates, particularly where the investment’s interest rate under the alternative will not be known at the same point in the investment period as LIBOR would have been.  They should also consider how to update systems and operational processes once certain market conventions and standards are agreed upon to accommodate alternative rates and, as applicable, ensure that they are able to transact in them as they become available.  Among other things, that work may include design, development, testing, implementation, documentation, and training, and may involve coordination with multiple third parties, such as custodians, administrators, advisors, brokers, vendors, co-investors, and sub-advisors.  In addition, market participants that have fallen behind on software releases may need to undertake systems upgrades, convert to new systems, or outsource the work in advance of vendor changes for LIBOR.  Market participants should be mindful that such efforts could take a significant amount of time and resources to complete.  In addition, market participants should consider how changes of terms for each LIBOR-linked investment will be communicated to investors and other stakeholders listed above so that information can be updated in systems and appropriate position and accrual adjustments can be made if needed.

Below are additional considerations for (1) broker-dealers regarding legal obligations when recommending LIBOR-linked securities; (2) broker-dealers underwriting primary offerings of municipal securities or recommending municipal securities; (3) investment advisers regarding legal obligations when recommending LIBOR-linked securities or otherwise providing advice regarding other LIBOR-linked investments; (4) funds and investment advisers related to disclosure, valuation, and operational issues; and (5) companies regarding their disclosure obligations related to the LIBOR transition.

Broker-Dealer Registrants:  Recommendations to Retail Customers

Given the announced discontinuation of the one-week and two-month USD LIBORs at the end of this year and the remaining USD LIBORs to be discontinued in 2023, broker-dealers should be especially mindful of their obligations when recommending LIBOR-linked securities or investment strategies involving LIBOR-linked securities to retail customers.[21]  As a threshold matter, a broker-dealer should carefully consider whether the securities or investment strategies it recommends to customers include LIBOR-linked securities, including securities with underlying investments in LIBOR-linked financial instruments.  For example, a fixed-income mutual fund that has a stated principal investment strategy of investments in underlying LIBOR-linked instruments could reasonably be considered a LIBOR-linked security.

Under Regulation Best Interest, a broker-dealer recommending LIBOR-linked securities or investment strategies involving such securities must have a reasonable basis to believe that the recommendation is in the best interest of the retail customer.[22]  Specifically, under Regulation Best Interest’s Care Obligation, a broker-dealer must exercise reasonable diligence, care, and skill to, among other things, understand the potential risks, rewards, and costs associated with the recommendation.[23]  A broker-dealer is also required to have a reasonable basis to believe, based on this understanding of the potential risks, rewards, and costs of the recommendation, and in light of the retail customer’s investment profile, that the recommendation is in the best interest of a particular retail customer.[24]

What constitutes “reasonable diligence, care, and skill” to understand the potential risks, rewards and costs will vary depending on, among other things, the complexity of, and risks associated with, the recommended security, as well as the broker-dealer’s familiarity with the recommended security.[25]  However, in general, a broker-dealer should consider factors such as the security’s investment objectives; characteristics (including any special or unusual features); liquidity; volatility; and likely performance in a variety of market and economic conditions; the expected return of the security or investment strategy; as well as any financial incentives to recommend the security or investment strategy.[26]  Together, this inquiry should allow a broker-dealer to develop a sufficient understanding of a security such that they may reasonably believe that it could be in the best interest of at least some retail customers.[27]

In light of the now-certain transition away from LIBOR, understanding the potential risks, rewards and costs is especially important when recommending LIBOR-linked securities.[28]  Consistent with this obligation, when making a recommendation of a LIBOR-linked security or investment strategy involving LIBOR-linked securities to retail customers, a broker-dealer should understand whether the LIBOR-linked security has robust fallback language in its offering documents or prospectus that includes a clearly defined alternative reference rate after LIBOR is no longer available,[29] as well as the impact of that replacement rate on the expected performance of a LIBOR-linked[30] security, to have a reasonable basis to believe that the recommended security is in a particular retail customer’s best interest.

For example, given the now-certain transition away from LIBOR as a reference rate, staff believes that it would be difficult for a broker-dealer to satisfy the Care Obligation where it recommends a LIBOR-linked security with no fallback language absent the recommendation being premised on a specific, identified, short-term trading objective.  The lack of fallback language as a practical matter guarantees that a material characteristic of the security at the time of the recommendation—the reference rate—will cease to exist during a period where a retail customer is likely to be holding the security.  The effect of LIBOR’s discontinuation in such a scenario on expected operation and returns of the security could be pronounced, particularly for longer-term notes that are expected to be held close to or beyond the applicable LIBOR cessation date.[31]  Accordingly, staff is of the view that the replacement rate for a LIBOR-linked security is a factor that generally should be considered as part of a recommendation.  Without understanding the terms, features, and risks of LIBOR-linked securities, which include the replacement rate, broker-dealers may not be able to establish a reasonable basis to recommend them to retail customers.[32]

Further, to the extent a broker-dealer has agreed to monitor a retail customer’s account, and that account includes holdings in LIBOR-linked securities, the broker-dealer should consider its obligations under Regulation Best Interest at the time the agreed-upon monitoring occurs.[33]  Specifically, if the broker-dealer agrees to perform account monitoring services for a retail customer, the broker-dealer has taken on an obligation to review and make recommendations with respect to that account (e.g., to buy, sell or hold) on that specified, periodic basis that the broker-dealer has agreed to with the retail customer.[34]  Moreover, if the broker-dealer agrees to perform account monitoring services, then Regulation Best Interest applies even when the broker-dealer remains silent (i.e., an implicit hold recommendation).[35]  Accordingly, when a broker-dealer has agreed to perform such account monitoring services, the broker-dealer must reassess the potential risks, rewards, and costs of any LIBOR-linked security in the retail customer’s account at the time of each agreed-upon periodic review, taking into consideration the most current information available on the state of the LIBOR transition and the potential effect on a customer’s LIBOR-linked security holdings.

Broker-Dealer Registrants:  Municipal Securities Underwriting and Sales to Customers

The July 2019 Staff Statement provided informal staff guidance on the potential impact that the expected discontinuation of LIBOR may have on broker-dealers, including with respect to broker-dealer sales practices in the context of the LIBOR transition.  In addition, as noted above, OMS staff has published a staff statement relating to the LIBOR transition focused on the activities of municipal obligors and municipal advisors.[36]  Broker-dealers that underwrite, trade or otherwise effect transactions in municipal securities should consider that statement in connection with their municipal securities activities, to the extent applicable.[37]  In addition, the Municipal Securities Rulemaking Board (“MSRB”) has published a discussion of some of the implications of the LIBOR transition for underwriters of municipal securities under MSRB Rule G-17.[38]

OMS staff notes that broker-dealers should consider the impact that the LIBOR transition may have in connection with other duties applicable to municipal securities activities, such as:

  • Underwriters of primary offerings of municipal securities subject to Exchange Act Rule 15c2-12 are obligated to, among other things, obtain and review a “deemed final” official statement prior to the time the underwriter bids for, purchases, offers, or sells the municipal securities.[39]  This is designed to assist the underwriter in fulfilling its obligation to have a reasonable basis for belief in the truth of key representations in such official statement, with the underwriter expected to, at a minimum, review the official statement in a professional manner for possible inaccuracies and omissions.[40]  Depending on the circumstances, disclosures about the municipal obligor’s exposure to risks due to the LIBOR transition, and steps taken to mitigate those risks, may be among such key representations.[41]
  • When recommending a municipal security transaction to a retail customer, a broker-dealer must comply with Regulation Best Interest, and as such, should review the discussion above regarding broker-dealer duties under Regulation Best Interest in the context of the LIBOR transition.[42]  Depending on the circumstances, information on the municipal obligor’s exposure to risks due to the LIBOR transition may need to be considered in making a best interest determination.
  • With limited exceptions, recommendations of municipal securities to investors other than retail customers (not subject to Regulation Best Interest) are subject to the suitability standard of MSRB Rule G-19.[43]  Depending on the circumstances, information on the municipal obligor’s exposure to risks due to the LIBOR transition may need to be considered in making a suitability determination.
  • Under MSRB Rule G-47, no broker, dealer, or municipal securities dealer shall sell a municipal security to a customer, or purchase a municipal security from a customer, whether unsolicited or recommended, and whether in a primary offering or secondary market transaction, without disclosing to the customer, orally or in writing, at or prior to the time of trade, all material information known about the transaction, as well as material information about the security that is reasonably accessible to the market.[44]  Depending on the circumstances, information known or available from established industry sources regarding the municipal obligor’s exposure to risks associated with the LIBOR transition may be material information under MSRB Rule G-47.[45]

Registered Investment Advisers and Funds

Investment advisers and funds should be mindful of their obligations under the Investment Advisers Act of 1940 (“Advisers Act”) and Investment Company Act of 1940 with respect to LIBOR-linked securities.

Investment advisers, including advisers to funds, have a fiduciary duty under the Advisers Act to act in their clients’ best interest, including duties of care and loyalty.[46]  The duty of care includes a duty to provide investment advice that is in the best interest of the client, and a duty to provide advice and monitoring over the course of the adviser’s relationship with the client.  In order to provide such investment advice, an adviser must have a reasonable belief that based on the client’s objectives, the advice is in the client’s best interest.  For example, advisers should consider whether investments are recommended only to those clients who can and are willing to tolerate the risks of those investments and for whom the potential benefits may justify the risks.  They should also conduct a reasonable investigation into the investments, sufficient not to base their advice on materially inaccurate or incomplete information.  Among the important factors to consider are an investment’s characteristics (including any special or unusual features), risks and potential benefits, volatility, likely performance in a variety of market and economic conditions, time horizon, and cost of exit.

In general, investment advisers should consider whether any advice regarding LIBOR-linked investments and applicable risks is consistent with their clients’ goals.  Because the cessation of LIBOR is likely to materially change the nature of certain investments, unless the adviser does not have an obligation to monitor, advisers should consider whether any LIBOR-linked investments they have recommended that clients purchase or continue to hold remain in the best interest of those clients.  Among other things, investment advisers should consider whether those investments or related contracts have robust fallback language providing for an alternative rate when LIBOR is no longer published or ceases to be representative of its underlying market.  Where fallback language references an alternative rate, advisers should consider whether any economic differences arising from the application of the alternative rate could cause the investment to depart from their clients’ strategy or risk tolerance.

Registered investment companies and business development companies should also be mindful of their disclosure obligations with respect to LIBOR.  These funds are required to disclose their principal risks in their prospectuses.[47]  These risks will depend on the fund’s investment objective(s), holdings, investment strategies, and structure.[48]  Private fund advisers also must state all material facts necessary to make the statements made to any investor or prospective investor in the fund not misleading.[49]  If a fund invests a significant portion of its assets in LIBOR-linked investments, it should disclose any principal risks related to the potential cessation of LIBOR, as well as the anticipated impact (and expected timing of that impact) on those investments, including with respect to volatility, value, and liquidity.

As noted above, valuation measurements that use LIBOR as an input, including those made by investment companies, are likely to be impacted in a variety of ways by the transition to an alternative reference rate.  Advisers, funds and fund boards should be mindful of any valuation risk and impacts to valuation inputs and assumptions associated with LIBOR and the transition.

Funds and advisers should also monitor and manage any conflicts of interest associated with the transition, including, for example, by considering their disclosure and other legal obligations relating to performance fees.  Some advisers and funds charge clients or investors a performance fee that is subject to a hurdle rate, which is the minimum return necessary for the adviser to start collecting the performance fee.  It is common for hurdle rates to be tied to a benchmark rate, such as LIBOR, or to an index that may contain LIBOR-linked securities.  Where applicable, advisers and funds should consider clearly disclosing how the benchmark rate will transition to a different one in advance of the LIBOR transition.  This should include disclosure that the transition to a new rate could make it easier to earn a performance fee.

Finally, as noted above, investment advisers and funds should be mindful that the transition away from LIBOR also introduces operational complexities that may require market participants (including investment advisers, funds and their key service providers) to make significant changes to their operational processes and IT systems, which could take a significant amount of time to complete.[50]  Advance coordination with other market participants on methods and timing to communicate changes to the terms of each LIBOR-linked investment held will be essential to navigate the transition.

Disclosure Considerations for Public Companies and Asset Backed Securities Issuers

The federal securities laws are designed to elicit disclosure of timely, comprehensive, and accurate information about risks and events that a reasonable investor would consider important to an investment decision.  It is important that companies keep investors informed about their progress toward LIBOR risk identification and mitigation, and the anticipated impact on the company, if material.  A number of existing rules or regulations may require disclosure related to the expected discontinuation of LIBOR, including rules and regulations related to disclosure of risk factors,[51] management’s discussion and analysis,[52] board risk oversight,[53] and financial statements.[54]  Issuers of registered asset-backed securities also should consider relevant disclosure requirements under Regulation AB,[55] as well as appropriate disclosures regarding the potential impacts of the LIBOR transition on investors in those securities.  To provide meaningful insight to investors about the status of their identification and mitigation efforts, including significant matters yet to be addressed, companies should consider providing detailed and specific disclosure, rather than general statements about the progress of the company’s transition efforts to date.

The staff encourages companies to provide qualitative disclosures and, when material, quantitative disclosures, such as the notional value of contracts referencing LIBOR and extending past December 31, 2021 or June 30, 2023, as applicable, to provide context for the status of the company’s transition efforts and the related risks.  For example, companies with material risk related to outstanding debt with inadequate fallback provisions should consider disclosing how much debt will be outstanding after the relevant cessation date and the steps the company is taking address the situation, such as renegotiating contracts or refinancing the obligations.  To the extent that a company has or is taking steps to identify and assess LIBOR exposure and mitigate material risks or potential impacts of the transition, the company should consider providing investors insight into what the company has done, what steps remain, and the timeline for further efforts.  Banking regulators have provided guidance to their regulated entities encouraging those banks “to cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021.”[56]  Companies subject to such supervisory guidance should consider providing detailed disclosure about their transition efforts and the impact of the efforts on the company, if material.

In general, companies generally include disclosures about the LIBOR transition as part of risk factors, recent developments, MD&A and/or quantitative and qualitative disclosures about market risk.  To the extent a company provides this disclosure in response to more than one disclosure requirement within a filing, consider providing a cross-reference or otherwise summarizing or tying the information together so an investor has a complete and clear view of the company’s plan for the discontinuation of LIBOR, the status of the company’s efforts, and the related risks and impacts.  The staff expects disclosures to evolve over time as companies provide updates to reflect transition efforts and the broader market and regulatory landscape.  For further information about disclosure considerations, companies are encouraged to refer to the July 2019 Staff Statement as they prepare their disclosures to investors about the LIBOR transition and its potential impact on their businesses.

ENDNOTES

[1] This statement represents the views of the staff of the U.S. Securities and Exchange Commission (“Commission” or “SEC”).  It is not a rule, regulation, or statement of the Commission.  The Commission has neither approved nor disapproved of its content.  This statement, like all staff statements, has no legal force or effect:  it does not alter or amend applicable law, and it creates no new or additional obligations for any person.

[2] LIBOR, which was formerly an acronym for “London Interbank Offered Rate,” is common parlance for its current official name, “ICE LIBOR.”  See “ICE LIBOR,” ICE Benchmark Administration (“IBA”), available at https://www.theice.com/iba/libor.  IBA is an independent subsidiary of Intercontinental Exchange, Inc., and is responsible for the end-to-end administration of the LIBOR benchmark.

[3] See Staff Statement on LIBOR Transition (Division of Corporation Finance, Division of Investment Management, Division of Trading and Markets, and the Office of the Chief Accountant) (“July 2019 Staff Statement”) (July 12, 2019), available at https://www.sec.gov/news/public-statement/libor-transition; OCIE Risk Alert, Examination Initiative:  LIBOR Transition Preparedness (June 18, 2020), available at https://www.sec.gov/files/Risk%20Alert%20-%20OCIE%20LIBOR%20Initiative_1.pdf;  Division of Examinations 2021 Examination Priorities, available at https://www.sec.gov/files/2021-exam-priorities.pdf; Office of Municipal Securities Staff Statement on LIBOR Transition in the Municipal Securities Market, Jan. 8, 2021, available at https://www.sec.gov/municipal/oms-staff-statement-libor-transition-municipal-securities-market (“OMS LIBOR Statement”).

[4] The considerations for broker-dealers in this staff statement are intended to be limited to recommendations of securities and investment strategies involving securities.  The considerations for investment advisers are intended to address the entire advisory relationship, which may extend to both securities and non-securities investments.  The term “investments” as used in this staff statement is intended to include, but is not limited to, securities.  For additional background regarding LIBOR, see July 2019 Staff Statement.  See also ICE, LIBOR webpage, available at https://www.theice.com/iba/libor.

[5] See Regulation Best Interest, Exchange Act Release No. 86031 (June 5, 2019) [84 FR 33318 (July 12, 2019)] (also referred to as “Reg BI”); Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Investment Advisers Act Release No. 5248 (June 5, 2019) [84 FR 33669 (July 12, 2019)] (“Fiduciary Interpretation”).

[6] LIBOR is quoted in five currencies—U.S. dollar (“USD”), British pound sterling, euro, Japanese yen, and Swiss franc—and for seven different maturities—overnight, one week, one month, two months, three months, six months, and 12 months.  This combination of currencies and maturities amounts to 35 different LIBOR rates reported each business day.  The alternative time frames, or “maturities,” are also commonly referred to as “tenors.”  See supra note 4.

[7] See supra note 4.

[8] See Alternative Reference Rates Committee (“ARRC”) Statement:  ARRC Commends Decisions Outlining the Definitive Endgame for LIBOR (March 5, 2021), available at https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2021/ARRC_Press_Release_Endgame.pdfSee also Intercontinental Exchange, Inc. (“ICE”) press release: ICE Benchmark Administration Publishes Feedback Statement for the Consultation on Its Intention to Cease the Publication of LIBOR Settings (March 5, 2021), available at https://ir.theice.com/press/news-details/2021/ICE-Benchmark-Administration-Publishes-Feedback-Statement-for-the-Consultation-on-Its-Intention-to-Cease-the-Publication-of-LIBOR-Settings/default.aspx.

[9] The ARRC is comprised of a diverse set of private-sector entities, each with an important presence in markets affected by USD LIBOR, and a wide array of official-sector entities, including banking and financial sector regulators, as ex-officio members.  See https://www.newyorkfed.org/arrc/about.  Market participants also should keep in mind that most major currency jurisdictions have identified a need for reforming major interest rate benchmarks.  Public and private-sector working groups, similar to the ARRC, have been formed in the other currencies for which LIBOR is quoted.  For example, the Working Group on Sterling Risk-Free Reference Rates has selected the Sterling Overnight Index Average (“SONIA”) as the UK’s preferred alternative reference rate.  SONIA is the effective overnight interest rate paid by banks for unsecured transactions in the British sterling market.  See Working Group on Sterling Risk-Free Reference Rates, available at https://www.bankofengland.co.uk/markets/ transition -to-sterling-risk-free-rates-from-libor/working-group-on-sterling-risk-free-reference-rates.

[10] See supra note 4.

[11] SOFR First is a phased initiative for switching trading conventions from LIBOR to SOFR for USD linear interest rate swaps, cross currency swaps, non-linear derivatives and exchange traded derivatives.  See CFTC Market Risk Advisory Committee Adopts SOFR First Recommendation at Public Meeting, CFTC Release No. 8409-21 (July 13, 2021), available at https://www.cftc.gov/PressRoom/PressReleases/8409-21. 

[12] This legislation mandates that, if a contract governed by New York law (i) references USD LIBOR as a benchmark interest rate and (ii) does not contain benchmark fallback provisions, or contains benchmark fallback provisions that would cause the benchmark rate to fall back to a rate that would continue to be based on USD LIBOR, then on the date USD LIBOR permanently ceases to be published, or is announced to no longer be representative, USD LIBOR will be deemed by operation of law to be replaced by the “recommended benchmark replacement.”  New York Senate Bill S297B, available at https://www.nysenate.gov/legislation/bills/2021/S297.  The legislation further provides that the “recommended benchmark replacement” shall be based on SOFR and shall have been selected or recommended by the Federal Reserve Board, the Federal Reserve Bank of New York or the ARRC for the applicable type of contract, security or instrument.  Id.

[13] For example, a security’s transaction documents may state that in the event LIBOR is not published, the security will use the last LIBOR published.  A permanent discontinuation of LIBOR could then have the material consequence of converting a floating-rate security to a fixed-rate security.  This is an example of what banking regulators have described as inadequate fallback language.  See Joint Statement on Managing the LIBOR Transition, Federal Financial Institutions Examination Council (July 1, 2020), available at  https://www.ffiec.gov/press/PDF/FFIEC%20Statement%20on%20Managing%20the%20LIBOR%20Transition.pdf (noting that “[i]f not sufficiently addressed, inadequate fallback language could post legal as well as safety and soundness risk”).

[14] See Summary of ARRC’s LIBOR Fallback Language, ARRC (Nov. 2019), available at https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2019/ LIBOR_Fallback_Language_Summary (providing model fallback language for several categories of investments, including floating rate notes and securitizations).  In addition, the International Swaps and Derivatives Association (ISDA) has been taking the lead on fallback language for derivatives contracts.  See Staff Statement on LIBOR Transition (July 12, 2019).

[15] See id.  Additionally, ISDA has led an effort to implement standardized fallback language effective Jan. 25, 2021 for derivatives contracts.  See “ISDA 2020 IBOR Fallbacks Supplement” (Oct. 23, 2020), available at http://assets.isda.org/media/3062e7b4/23aa1658-pdf.

[16] See Summary of ARRC’s LIBOR Fallback Language, supra note 13; see also Joint Statement on LIBOR Transition by the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (Nov. 30, 2020) (directing that new contracts “should either utilize a reference rate other than LIBOR or have robust fallback language that includes a clearly defined alternative reference rate after LIBOR’s discontinuation” but mandating no particular alternative rate) available at  https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20201130a1.pdf.

[17] See ARRC Formally Recommends Term SOFR, ARRC (July 2021), available at https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2021/ARRC_Press_Release_Term_SOFR.pdf.

[18] For example, SOFR is an overnight rate that could be applied in a credit agreement by taking the average overnight rate over a future period, or average SOFR over a historical time-period.  In short, investors may need to know not only which alternative rate is used, but also the mechanics of how the rate will be calculated in a particular credit agreement.

[19] Additional Commission-related materials have discussed the risks associated with LIBOR discontinuation, as well as related legal obligations.  See, e.g., Divisions of Examinations 2021 Examination Priorities, and OCIE Risk Alert, Examination Initiative:  LIBOR Transition Preparedness, supra note 3 (providing registrants with information regarding examinations to assess their preparations for the expected discontinuation of LIBOR and the transition to an alternative reference rate); OCIE, Examination Priorities for 2020; Speech by SEC Chairman Jay Clayton, SEC Rulemaking Over the Past Year, the Road Ahead and Challenges Posed by Brexit, LIBOR Transition and Cybersecurity Risks (Dec. 6, 2018).

[20] See ARRC Buy-Side/Asset Owner Checklist at Section 8 (Operational and technology readiness), Section 9 (Accounting and Reporting, including Investment and Client Accounting) (Jan 2020), available at https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC_Buy_Side_Checklist.pdfSee also ARRC Internal Systems and Processes: Transition Aid for SOFR Adoption (July 8, 2020), available at https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC-Internal-Systems-Processes-Transition-Aid.pdf.

[21] A retail customer is a natural person, or the legal representative of such natural person, who (i) receives a recommendation of any securities transaction or investment strategy involving securities from a broker, dealer, or a natural person who is an associated person of a broker or dealer; and (ii) uses the recommendation primarily for personal, family, or household purposes.  See 17 C.F.R. § 240.15l-1.

[22] See 17 CFR §240.15l-1(a)(2)(ii) (the “Care Obligation” of Regulation Best Interest).

[23] See id.

[24] See id.

[25] See Regulation Best Interest, supra note 5 at 33376.

[26] See id.

[27] See id.

[28] See id.

[29] See Board of Governors of the Federal Reserve System, SR 21-7: Assessing Supervised Institutions’ Plans to Transition Away from the Use of the LIBOR (March 9, 2021) available at https://www.federalreserve.gov/ supervisionreg/srletters/SR2107.htm.  LIBOR-linked securities may have fallback language tied to any number of alternative rates, including the Federal Funds rate, the Prime rate, or another rate that may be at the discretion of the issuer or other agent to select.

[30]  For example, broker-dealers should have a general understanding that SOFR is typically lower than LIBOR; therefore, ARRC-recommended fallback language includes replacing LIBOR with SOFR plus a spread.  The absence of a spread in such an instance would be unusual and its absence should carefully be considered.

[31] Investment advisers should similarly be aware of the effect of LIBOR discontinuation in such a scenario.  See infra at 10-12 (discussing investment adviser duties).

[32] However, a broker-dealer might, depending on the specific facts and circumstances, take into account the applicability of New York state legislation designed to address LIBOR-linked securities with no fallback language that are governed by New York state law.  See supra note 12.

[33] This statement does not change the scope of account monitoring that broker-dealers may agree to provide.  See Regulation Best Interest, supra note 5.  Investment advisers should similarly be aware of their fiduciary duty when monitoring accounts including holdings in LIBOR-linked securities or other financial instruments referencing LIBOR.  See infra at 10-12.

[34] See Regulation Best Interest, supra note 5 at 33340-41.

[35] See id.

[36] See OMS LIBOR Statement, supra note 3.

[37] To effect transactions in municipal securities, a person must be a broker-dealer subject to registration with the Commission under Section 15(b)(1) of the Exchange Act or a municipal securities dealer subject to registration with the Commission under Section 15B(a)(2) of the Exchange Act. See 15 U.S.C. 78f(b)(1); 15 U.S.C. 78o-4(b)(2)(C).

[38] See “LIBOR Transition Information: Underwriters’ Fair Dealing Obligation,” available at http://www.msrb.org/Regulated-Entities/Resources/LIBOR-Information.

[39] 17 C.F.R. § 240.15c2-12(b)(1).

[40] See Exchange Act Release No. 26100 (Sept. 22, 1988), 53 FR 37778 (Sept. 28, 1988) at 37789 (File No. S7-20-88).

[41] See OMS LIBOR Statement, supra note 3 (“Consistent with this observation, OMS staff believes that municipal obligors should consider the need to make appropriate disclosures regarding the material risks related to the expected discontinuation of LIBOR, and mitigating actions taken in response”).

[42] See Securities Exchange Act Release No. 89154 (June 25, 2020); 85 FR 39613, 39614 (July 1, 2020) (File No. SR-MSRB-2020-02).  Bank dealers are not subject to Regulation Best Interest, and remain subject to the existing obligations of suitability for recommendations to retail customers under MSRB Rule G-19.  The MSRB has issued a request for comment on whether the MSRB should revise its rules to apply Regulation Best Interest to bank dealers.  See “Request for Comment on Application of Regulation Best Interest to Bank-Dealer,” MSRB Notice 2021-06 (Mar. 4, 2021).  MSRB Rule D-8 defines a bank dealer as a municipal securities dealer which is a bank or a separately identifiable department or division of a bank as identified by MSRB Rule G-1.  See MSRB Rule D-8.

[43] See MSRB Rule G-19.  While natural persons who qualify as sophisticated municipal market professionals under MSRB Rule D-15 are subject to Regulation Best Interest as retail customers, MSRB Rule G-48 provides that the customer-specific suitability requirement under MSRB Rule G-19 does not apply to sophisticated municipal market professionals who are not natural persons.  See MSRB Rule G-48; see also MSRB Rule G-19.   

[44] See MSRB Rule G-47.  Information is reasonably accessible to the market if available publicly through established industry sources.  Id.  Established industry sources include the MSRB’s Electronic Municipal Market Access system, rating agency reports, and other sources of information on municipal securities transactions generally used by broker-dealers that effect transactions in the type of municipal securities.  Id.

[45] Id.

[46] See Fiduciary Interpretation, supra note 5.

[47] See e.g., Form N-1A, Item 4(b)(1)(i).

[48] See Accounting and Disclosure Information No. 2019-08, Improving Principal Risks Disclosure, available at https://www.sec.gov/investment/accounting-and-disclosure-information/principal-risks/adi-2019-08-improving-principal-risks-disclosure.

[49] See Rule 206(4)-8(a)(1) under the Advisers Act (17 CFR 275.206(4)-8(a)(1)).

[50] See supra note 19 and accompanying text.

[51]  Item 105 of Regulation S-K and Item 3.D of Form 20-F require companies to disclose the most significant factors that make an investment in the company speculative or risky and, in making these disclosures, to avoid “boilerplate” disclosure and instead provide disclosures that are tailored to the company’s facts and circumstances.

[52]  Item 303 of Regulation S-K and Item 5 of Form 20-F require companies to identify, among other items, known trends or known demands, commitments, events, or uncertainties that will result or that are reasonably likely to result in a material increase or decrease in liquidity, and to describe any known trends or uncertainties that have had, or that a company reasonably expects may have, a material favorable or unfavorable impact on income.

[53] Item 407(h) of Regulation S-K requires companies to disclose the extent of its board’s role in the risk oversight of the company, such as how the board administers its oversight function and the effect this has on the board’s leadership structure.

[54] Risks related to the expected discontinuation of LIBOR, and mitigating actions taken in response, may have broad impact on a company’s financial statements.  See July 2019 Staff Statement, supra note 3.

[55] Item 1113(a)(3) of Regulation AB requires an issuer of asset-backed securities to disclose how the interest rate on the asset-backed securities is determined and how frequently it will be determined.  Item 1125 of Regulation AB also requires issuers of asset-backed securities backed by residential mortgages, commercial mortgages, auto loans and leases, debt securities and resecuritizations of those asset classes to provide specified asset-level information for each asset in the pool, including the applicable benchmark for each floating rate asset.  Because this asset-level information is required to be provided both at the time of the offering and on an ongoing basis, LIBOR transition may necessitate changes to an issuer’s ongoing asset-level disclosures.

[56] See Statement by the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation, available at https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20201130a1.pdf.  The agencies provided additional guidance to regulated entities on October 20, 2021.  See LIBOR Transition:  Joint Statement on Managing the LIBOR Transition available at https://www.occ.gov/news-issuances/bulletins/2021/bulletin-2021-48.html.

This statement was issued on December 7, 2021, by the staff of the U.S. Securities and Exchange Commission.

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