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LIBOR transition readiness checklist for corporates

Date:
December 3, 2020

Summary

This proprietary checklist is informed by Chatham Financial's team of hedging, regulatory, and accounting advisors with visibility across 100+ banks and 3,000+ clients. By taking these 12 key actions, your treasury and accounting teams can confidently prepare for the transition from LIBOR to SOFR.

To prepare for the transition from LIBOR, your organization may need to take immediate action from a regulatory, accounting, and operational perspective. With the November 30 Fed announcement that LIBOR replacement will now be completed in June 2023, transition teams must decide which areas (such as Topic 848 documentation) need action now and where a wait-and-see approach is appropriate. Several of these actions will take weeks or months to implement so you should begin proactively engaging in the process.

Regulatory action items

Begin preparing for the transition from LIBOR by understanding the ISDA Fallbacks Protocol (effective January 25, 2021) so you can make decisions about how they impact your current agreements and whether you should adhere to the Protocol, negotiate bilaterally, or pursue a combination based on the terms of each agreement. Since this decision depends on numerous factors and varies considerably for each organization, you should gain a full understanding of how each alternative will impact your organization and its portfolio.

  • Assess existing IBOR fallback language, including triggers, replacement rates, and spread adjustments

  • Evaluate Protocol and ARRC suggested fallbacks and decide whether to adhere or bilaterally negotiate with counterparties

  • Navigate ISDA Protocol adherence and/or bilateral negotiation with counterparties

Accounting action items

While many corporations consider maintaining hedge accounting a critical outcome of the LIBOR transition, this is by no means guaranteed. Your transactions will now be valued differently, require amended documentation, and need systems that support these changes. The discounting transition from Overnight Indexed Swap (OIS) to Secured Overnight Financing Rate (SOFR) is considered a change in valuation methodology and may require additional disclosures in your financial statements. Your company and its auditors will need to assess the materiality of the impact and include appropriate disclosures.

Additionally, if you apply hedge accounting to existing (or legacy) swaps, the expected phase-out of LIBOR and adherence to the ISDA Protocol may be considered events that require de-designation of the hedging relationship. Topic 848 ("Reference Rate Reform") provides specific optional expedients addressing these events and may allow you to continue the existing hedging relationship without being impacted by the changes. However, you must document the elections prior to the issuance of year-end financial statements. It is also critical to confirm your systems are ready to support SOFR discounting and the accounting treatment for SOFR-based instruments. You must also ensure that you have sufficient operational support for accounting and reporting.

  • Update hedge accounting documentation and disclosures in accordance with Topic 848 to avoid accounting issues

  • Determine whether changes in derivative critical terms from LIBOR to SOFR may trigger a de-designation of the hedging relationship

  • Manage system impact and operationalize the transition for smooth accounting and reporting

  • Evaluate forward hedging strategies for exposure beyond 2021

Operational action items

Given the complexity and interaction between multiple financial instruments, you will need to evaluate and implement new processes, systems, and approaches to enable smooth continuation of your organization's hedging programs. Begin by taking inventory of your hedging instruments and then use this information to address system impacts, economic transition considerations, and future hedging structures.

  • Inventory legacy LIBOR exposure

  • Transition portfolio valuations from OIS to SOFR discounting

  • Verify spread adjustments and SOFR product terms once LIBOR cessation is effective

  • Analyze existing hedging strategies and assess long-term approach to hedging; terminate or amend existing hedges, if appropriate

  • Re-assess capital structure and total SOFR exposures post-transition

Next steps

Because the transition from LIBOR can impact your existing debt and derivatives portfolios, ongoing financial risk management strategy, and capital structure, successfully managing the transition is critical. The above checklist can serve as a guide for assessing this impact and preparing for a successful transition that minimizes the economic, accounting, and regulatory risks to your organization. Because numerous variables can impact each corporation's transition plan, you will likely encounter additional issues and questions. If you are considering adhering to the Protocol or require assistance with SOFR discounting or accounting documentation, Chatham's LIBOR transition team can provide a comprehensive support and guidance.

Chatham Financial corporate treasury advisory

Chatham Financial partners with corporate treasury teams to develop and execute financial risk management strategies that align with your organization’s objectives. Our full range of services includes risk management strategy development, risk quantification, exposure management (interest rate, currency and commodity), outsourced execution, technology solutions, and hedge accounting. We work with treasury teams to develop, evaluate, and enhance their risk management programs and to articulate the costs and benefits of strategic decisions.


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Disclaimers

Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.

Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.

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