October 25, 2021 - by Tess Virmani. updated on Nov 9, 2021. Last week, five financial institution regulatory agencies, including the OCC, Fed and FDIC, issued a joint statement on LIBOR transition which shed further light on the question at the top of everyone’s minds: What is a new LIBOR contract?
With nearly two months to go until the end of 2021, market participants are preparing for – and scrutinizing – the interagency supervisory guidance issued in November 2020 which “encourage[d] banks to cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021.” While the agencies’ intent is clear – no new LIBOR contracts after the end of the year – market participants still wonder how that broad rule gets applied to some of the common flavors of loans, including uncommitted lines of credit, incremental debt and amendments. In the recent release, the agencies reiterated their belief that entering into new contracts, including derivatives, that use LIBOR as a reference rate after December 31, 2021, would create safety and soundness risks. The release went on to state that: “a new contract would include an agreement that (i) creates additional LIBOR exposure for a supervised institution or (ii) extends the term of an existing LIBOR contract.” The agencies did offer comfort though that they were not looking to cause any market disruption of interfere in the contractual arrangements supervised institutions have with their customers. The following would not be a new contract: “a draw on an existing agreement that is legally enforceable (e.g., a committed credit facility).” Recognition that supervised institutions are party to contractual arrangements where LIBOR-referenced funding will occur after the end of the year squarely describes post 2021 draws on revolving credit facilities or delayed draw term loans, but also would seemingly permit supervised entities to honor commitment papers that they signed in 2021 even if the facilities would not close until after year-end. (It is important to note that we understand the regulatory supervisors have made it very clear to supervised entities that new commitment papers referencing LIBOR should have no place in 4Q21 activity.) The focus of the agencies on “legally enforceable” obligations of supervised entities with respect to assessing new contracts will undoubtedly inform the position of supervised institutions with respect to uncommitted lines – and likely raise specific questions with each institution’s bank examiners. In addition, the joint statement offered guidance on the use of alternative reference rates. The statement recalled that the Fed, FDIC, and OCC have previously communicated – as recently as October 5th – that a supervised institution may use any reference rate for its loans that the institution’s management determines is appropriate based on its funding model and customer needs. When looking to use an alternative reference rate, like a credit sensitive rate, supervised institutions should understand how their chosen reference rate is constructed and be aware of any fragilities associated with that rate and the markets that underlie it. That is the standard message that the agencies have given with respect to alternative references rates. However, as reported last week, market participants should be aware that the OCC separately released a self-assessment tool pointing to specific hurdles supervised institutions would be expected to meet when using alternative reference rates.
