SEC raises expectations for public disclosures on LIBOR transition risks

On July 12, 2019, the U.S. Securities and Exchange Commission Staff (SEC staff) released a public statement encouraging entities to prepare for transition away from LIBOR and to provide disclosures about those transition plans and related risks. The SEC staff recommended that market participants expand their disclosures to include items such as the type and number of impacted instruments, the status of transition efforts to date, and related risks the entity will manage throughout the interim period.

LIBOR is scheduled to cease at the end of 2021. In support of that timetable, the Chicago Mercantile Exchange and LCH.Clearnet will begin discounting cleared derivatives using the Secured Overnight Financing Rate (SOFR) during the second half of 2020. These changes will likely provide additional liquidity to the SOFR market and accelerate the transition from USD LIBOR to SOFR.

The recent SEC public statement requested public companies to initiate or increase the specific disclosure of activities and risks related to their LIBOR transition activities. While FASB and IASB are working to minimize the accounting and financial reporting impact of the transition, market participants are encouraged to provide investors with candid disclosures addressing the status of remediation efforts to date, and financial and non-financial risks to be managed throughout the interim period. These disclosures will require new information and companies should initiate a LIBOR transition project, if one has not already begun.

A summary of key messages from the public statement

1. Assess existing contracts and positions
   1. Assess whether the entity or its customers are exposed to contracts extending past 2021 linked to LIBOR. For each contract identified, assess the effect LIBOR discontinuation will have on the operation of each.
   2. For contracts lacking appropriate fallback language, identify actions to mitigate risk.
   3. Assess whether there are fundamental differences between LIBOR and the ARR(s) that might replace LIBOR that could impact profitability or costs.
   4. Assess impact on the company’s hedging strategy, if any.
   5. Identify primary business risks associated with the change: will any natural hedges be lost? Will items need to shift in or out of the trading portfolio to maintain the risk profile?
2. Assess plan for new contracts and positions
   1. Apply updated fallback language to new transactions — already defined for FRNs, syndicated loans, bilateral business loans and securitizations.
   2. ISDA effort underway for derivatives contracts; identify instruments where uncertainty remains and plan accordingly.
3. Assess other related risks
   1. Assess impact on strategy, products, processes, and systems.
   2. Identify where the transition may give rise to new risks, including financial, operational, legal, regulatory, technology, and other risks.

Selected excerpts of commentary from SEC divisional units

• Division of Corporate Finance: Include assessment in management’s discussion and analysis, board risk oversight, and financial statements. Keep investors informed about the state of risk identification and mitigation, and the anticipated impact on the company. Keep statements current in each reporting period, note exposures identified where impact has not yet been assessed, and allow investors to see this issue “through the eyes of management,” i.e., align statements to the scope and degree of transparency in management reporting, where possible.
• Division of Investment Management: Fund managers, particularly those with floating rate debt, bank loans, LIBOR-linked derivatives and certain ABS, must understand the functioning, liquidity and value of those investments.
• Division of Trading and Markets: Broker/dealers, CCPs, and exchanges should identify instances of legacy exposure in issuance, trading, hedging, underwriting, placement, and advisory; assess impacts to business strategy, systems, models, processes, risk management frameworks, and clients; and develop an appropriately scaled remediation plan. Consider the need for disclosures to clients and markets in addition to investors.
• Office of the Chief Accountant: Consider impacts on both financial reporting and accounting policy. Specific focus areas might include modifications of terms within debt instruments; hedging activities; inputs used in in valuation models; and potential income tax consequences.