On July 29th, 2021, the Alternative Reference Rates Committee (ARRC) and the Office of the Comptroller of the Currency (OCC) published guidance on the LIBOR transition. The ARRC formally recommended the Chicago Mercantile Exchange (CME) Group’s forward looking Secured Overnight Financing Rate (SOFR) Term Rates, and the OCC addressed the continued regulatory capital eligibility of capital instruments that a financial institution replaces or amends as a result of the transition from LIBOR.
What this means
The ARRC’s formal recommendation of SOFR Term Rates is a major milestone in the transition away from U.S. Dollar (USD) LIBOR, and marks the completion of the Paced Transition Plan outlined by the ARRC in 2017.
The continued growth in SOFR cash and derivatives markets has allowed the ARRC to recommend these rates, consistent with the principles it established in the Paced Transition Plan. This formal recommendation follows the ARRC’s July 21st, 2021, announcement of conventions and best practices for the use of SOFR Term Rates. These can all be referenced when market participants use SOFR Term Rates in legacy fallbacks and new contracts to prepare for the LIBOR cessation.
“With this step, market participants now have every tool they need to transition from LIBOR,” said Randal Quarles, Vice Chair for Supervision of the Federal Reserve Board and Chair of the Financial Stability Board. “All firms should be moving quickly to meet our supervisory guidance advising them to end new use of LIBOR this year.”
Additionally, the OCC published two Frequently Asked Questions (FAQs) on replacing or amending the terms of a capital instrument to transition from LIBOR to an alternative reference rate be considered the issuance of a new instrument, and would it be considered creating an incentive to redeem the instrument, under the existing capital rule 12 CFR 3.
Firstly, the OCC does not consider the replacement or amendment of a capital instrument that solely replaces a reference rate linked to LIBOR with an alternative rate to constitute an issuance of a new capital instrument. A financial institution that replaces or amends the terms of a capital instrument should however support its determination with analysis that demonstrates that the replacement instrument is not substantially different from the original from an economic perspective.
Secondly, the OCC does not consider the replacement or amendment of a capital instrument to be creating an incentive to redeem such instrument, as long as the replacement instrument is not substantially different from the original LIBOR benchmarked instrument. Again, financial institutions should support this determination with appropriate analysis.
The guidance from both the ARRC and the OCC provides further clarity in the LIBOR transition.
“This formal recommendation of SOFR Term Rates is an achievement for the USD LIBOR transition specifically and for financial stability overall.” Said Tom Wipf, ARRC Chair, “With just five months until no new LIBOR, significant work remains and I urge everyone with LIBOR exposures to immediately take action and base their new contracts on forms of SOFR.”
- ARRC Formally Recommends Term SOFR https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2021/ARRC_Press_Release_Term_SOFR.pdf
- LIBOR Transition: Regulatory Capital Rule FAQs https://www.occ.gov/news-issuances/bulletins/2021/bulletin-2021-32.html
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