December 23, 2021
First, what is LIBOR? The London Interbank Offered Rate (“LIBOR”) is the average interest rate by which major global banks borrow from one another. LIBOR rates that are not based on the U.S. Dollar will be discontinued on December 31, 2021, while those linked to the U.S. dollar will remain until June 30, 2023. In LIBOR’s place will be a new rate, the Secured overnight Financing Rate (“SOFR”), which will measure the cost of overnight cash borrowing. This new rate will be backed by U.S. Treasury securities and based on directly observable treasury-backed repurchased transactions.
The SEC Staff Statement from December 7, 2021 (see here) warns investment advisers and broker-dealers alike of the potential violation of Regulation Best Interest by recommending LIBOR-linked securities. Before the end of the year, when LIBOR is phased out, the SEC recommends advisers and broker-dealers consider any obligations associated with Regulation Best Interest and their fiduciary duties before recommending LIBOR-linked securities or investment strategies.
The SEC warns that broker-dealers may find it challenging to satisfy their duty of care under Regulation Best Interest if they recommend LIBOR-linked securities with no fallback language absent the recommendation being for a specific, identified, short-term trading objective.
LIBOR-linked securities are an investment product, similar to a mutual fund, that has a principal investment strategy of investments in underlying LIBOR-linked instruments. Analyses of LIBOR-linked securities should include:
Registered investment advisers must also assess whether LIBOR-linked investments fit their clients’ goals. It is not shocking to believe that the phasing out of LIBOR is likely to cause material changes to the nature of certain investments. Therefore, unless the adviser does not have an obligation to monitor, advisers should consider whether any LIBOR-linked investments they have recommended in the past should continue to be held in the best interest of the client. Also, investment advisers should determine how the post-LIBOR replacement rate could impact the security.
Investment advisers must disclose:
The SEC warns that there is potential for certain conflicts of interest to arise that will require disclosure. The Commission also brought light to the fact that the transition could create delays and operational complexities.
WHAT DOES THIS MEAN FOR ME?
The SEC shared that advisers should take inventory of the products in customer accounts that are linked to the rate and whether these products are prepared for LIBOR to be phased out.
If your firm requires assistance with understanding and staying up to date with SEC regulations, Fairview can help. We can help firms register with the SEC and support registered investment advisers by creating and implementing comprehensive, sustainable compliance programs with the help of our in-house regulatory experts. Contact us today for more information about our services.
Firms should also use back-office systems that can appropriately search and test the securities for bugs. Contact Fairview Investment Services for support if you need help implementing any of these regulatory requirements.