On Friday, July 12, 2019, the Securities and Exchange Commission’s Divisions of Corporation Finance, Investment Management and Trading and Markets, and the SEC’s Office of the Chief Accountant issued a statement regarding the LIBOR phase out, focusing attention on the “urgency” of implementing alternative reference rates.  The statement references the work of the Alternative Reference Rates Committee (ARCC) in identifying the Secured Overnight Funding Rate (SOFR) as the preferred alternative rate for USD LIBOR.

The Staff encourages market participants to identify contracts extending past the 2021 LIBOR phase out date in order to assess their LIBOR-related exposures.  To that end, the release poses the following questions for registrants:

  • Do you have or are you or your customers exposed to any contracts extending past 2021 that reference LIBOR?  For companies considering disclosure obligations and risk management policies, are these contracts, individually or in the aggregate, material?
  • For each contract identified, what effect will the discontinuation of LIBOR have on the operation of the contract?
  • For contracts with no fallback language in the event LIBOR is unavailable, or with fallback language that does not contemplate the expected permanent discontinuation of LIBOR, do you need to take actions to mitigate risk, such as proactive renegotiations with counterparties to address the contractual uncertainty?
  • What alternative reference rate (for example, SOFR) might replace LIBOR in existing contracts?  Are there fundamental differences between LIBOR and the alternative reference rate – such as the extent of or absence of counterparty credit risk – that could impact the profitability or costs associated with the identified contracts?  Does the alternative reference rate need to be adjusted (by the addition of a spread, for example) to maintain the anticipated economic terms of existing contracts?
  • For derivative contracts referencing LIBOR that are utilized to hedge floating-rate investments or obligations, what effect will the discontinuation of LIBOR have on the effectiveness of the company’s hedging strategy?
  • Does use of an alternative reference rate introduce new risks that need to be addressed?  For example, if you have relied on LIBOR in pricing assets as a natural hedge against increases in costs of capital or funding, will the new rate behave similarly?  If not, what actions should be taken to mitigate this new risk?

For new contracts, the statement references the ARCC and the ISDA fallbacks.

Each Division and the Office of the Chief Accountant also provided specific guidance.  The guidance from the Division of Corporation Finance is consistent with prior statements, urging registrants to consider their disclosures relating to risks, results of operations, new products, etc.  The guidance from the Office of Chief Accountant notes that the transition from one benchmark rate to another can have a significant impact on a company’s accounting and could give rise to issues affecting inputs used in valuation models, hedge accounting, and income tax questions.  See the full statement here.