The Alternative Reference Rate Committee (ARRC) and the International Swaps and Derivatives Association (ISDA) are looking for feedback from corporate end-users on how the transition away from the London Interbank Offered Rate (Libor) could impact them. They are particularly focused on fallback contract language.
The ARRC is seeking comment on consultations on U.S. dollar Libor fallback contract language for floating rate notes and syndicated business loans. The consultations outline draft language for new contracts that reference Libor to minimize disruptions should Libor no longer be usable.
The ARRC aims to gather feedback not only on its proposed approach, but also the key issues involved. Any feedback it receives will be taken into account before it publishes its final recommendations for market participants’ use.
“The public and private sector share the recognition that there is a strong possibility that Libor may discontinue, and the associated risks are considerable,” said Sandra O’Connor, chair of the ARRC and chief regulatory affairs officer for JPMorgan Chase & Co. “That’s why these consultations for fallback contract language are a crucial development in creating a more resilient financial regime.”
The ARRC said that the release of these consultations marks the start of a public comment period, during which it will work closely with end-users to gather and incorporate their input. Comments are due by November 8, 2018.
The ARRC has also published a list of frequently asked questions on the Libor transition. The FAQ is ideal for treasury professionals seeking more information on the transition, the ARRC itself, and details on the ARRC’s “Paced Transition Plan” that urges U.S. businesses to voluntarily switch to the Secured Overnight Financing Rate (SOFR) over the next several years.
ISDA also has a consultation out to the public regarding fallbacks. It is amending its standard documentation to implement fallbacks for certain key interbank offered rates (IBORs). Fallbacks can apply if an IBOR is permanently discontinued, based on defined triggers. The fallbacks will be to alternative risk-free rates (RFRs) that have been identified for relevant IBORs as part of recent global benchmark reform work. ISDA is seeking input on the approach for addressing certain technical issues associated with adjustments that will apply to the RFRs if the fallbacks are triggered. Given the differences between the IBORs and the RFRs, these adjustments are needed. Comments are due by October 12, 2018.
Although ISDA’s consultation doesn’t cover USD Libor, Jennifer Earyes, director of treasury risk for Navient and a member of the ARRC, stills sees value in U.S. treasurers voicing their concerns. “They asked for people who have thoughts about USD Libor, so we are commenting,” she said.
During its meeting last month, the Financial Account Standards Board (FASB) concluded discussions on its proposed Accounting Standards Update (ASU) and the possible addition of the Overnight Index Swap (OIS) rate, which is based on SOFR as a U.S. benchmark interest rate for hedge accounting.
The FASB board tentatively confirmed that the OIS rate, based on SOFR, would be added to the list of acceptable U.S. benchmark interest rates. The board has committed to monitoring the development of the SOFR term rate in the future and would consider adding it as a benchmark rate if warranted. The board also confirmed that entities would apply the provisions of the ASU prospectively to “qualifying new or redesignated hedging relationships entered on or after the date of adoption,” and will not require any additional disclosure. FASB is also adding a new project to its agenda to mitigate the effects of the Libor to SOFR transition on financial reporting.
FASB’s new hedge accounting guidance can help practitioners who want to make an early transition to a new reference rate, largely by being very user-friendly, explained the treasurer for a major retailer who requested to remain anonymous. “They’ve made a lot of changes,” he said. “For the first time in my life, I’ve seen changes that come from the practitioners’ perspective.”
The treasurer noted that FASB is unique in that it’s focused on the effect of the Libor transition, whereas other players like the UK Financial Conduct Authority and the U.S. Federal Reserve are focused on the cause. “FASB is thinking, ‘If the change happens, how do you take care of it?’” he said. “They have no authority over Libor or the banks. But how Libor is being used for accounting purposes—that’s where they come in.”
Corporate Confusion on Libor
Although corporate treasury professionals need to pay attention to these developments, many of them aren’t doing so. “To tell you the truth, corporates are not as worried, because it’s not their specific problem; it’s a global problem,” the retail treasurer said. “When it’s a global problem, people have this weird idea that somebody is going to take care of it. There are so many corporates who think that the SEC or somebody else will come in and take care of this problem, because as one corporate, you cannot.”
Earyes compared and contrasted the current situation with the passage of Dodd-Frank in 2010. Back then, corporate practitioners’ concerns were not really addressed by regulators. “The corporates weren’t used to banding together, and we weren’t at the table,” she said. “So now at least with Libor, the authorities are at least trying to get those folks at the table to talk about it. But that mentality is still there that we can’t really change anything.”
Furthermore, because there is no central regulatory authority in control of Libor, practitioners—particularly those in the United States—aren’t even sure who they should appeal to if they want to have their voices heard. The U.S. Federal Reserve is pushing for a transition to SOFR, but it can’t actually force businesses to make the move. “They don’t have the ability to mandate through the Federal Reserve, which is not an issue for other countries,” said Tom Hunt, CTP, AFP’s director of treasury services. “So you have different countries producing their own equivalents, but all based on a similar methodology to SOFR.”
And SOFR isn’t exactly catching on like wildfire. “ISDA reported that there were only 14 derivatives referencing SOFR at the end of August,” Earyes said. She added that David Bowman, Special Advisor to the Fed's Board of Governors and a leading Libor expert in her ARRC working group, has stressed to banks and corporates the importance of actively engaging in the consultation process and it’s up to the industry to start trading SOFR-indexed derivatives.
What You Can Do
U.S. treasury professionals are encouraged to provide comment to the ARRC and ISDA, as well as review ARRC’s FAQ if they have any questions. Senior-level treasury practitioners should also plan on attending the session, Libor: The World’s Biggest Number in Transition at the Executive Institute at AFP 2018. And for more tips, be sure to visit AFP’s Libor Transition Guide.