SEC Risk Alert on Observations of LIBOR-Transition Preparedness

May 15, 2023

WHAT HAPPENED?

On May 11, 2023, the SEC’s Division of Exams (“EXAMS”) published a Risk Alert to remind registrants of the discontinuation of U.S. Dollar LIBOR after June 30, 2023. The Risk Alert also discussed firms’ practices to manage the transition. In its examinations of registered investment advisers and investment companies, EXAMS noted the following actions firms took to transition away from LIBOR:

Risk Management

• “Treatment as an enterprise risk governance matter.” Firms heavily impacted by the LIBOR transition adopted practices such as maintaining a risk governance committee; producing detailed written transition plans; and creating comprehensive impact assessments.
• “Keeping informed and engaged in industry associations.” EXAMS noted that most firms it encountered used recommendations from the Alternative Reference Rates Committee, or were members themselves. Many firms were also having LIBOR transition discussions with industry groups.
• “Internal Training and Guidance.” EXAMS found that firms were conducting trainings on both the LIBOR transition and any firm-specific changes to address its impacts.

Operations

• “Active engagement with service providers, sub-advisers, and third-party managers.” EXAMS noted that firms used due diligence questionnaires and outreach to assess the extent to which these entities were prepared for the LIBOR transition.
• “Extensive systems testing.” Certain firms conducted end-to-end testing to ensure that their systems could accommodate alternative reference rates (AAR).
• “Reconciliation of settlements and payments.” EXAMS noted that many firms began a rigorous reconciliation process to ensure the terms and conditions of the AARs.

Portfolio Management

• “Early identification of LIBOR exposures.” Many firms considered LIBOR exposure among subsidiaries and affiliates, and tracked exposure internally.
• “Substantive review of fallback provisions.” EXAMS found that many firms leveraged third-party service providers to identify fallback provisions, particularly those that might be difficult to transition.
• “Internal controls and guidance concerning trading of LIBOR-linked contracts.” Some firms considered the need for trading restrictions on new and legacy LIBOR-linked instruments.
• “Early transitioning of bank loans and other instruments.” EXAMS noted that some firms converted to AARs as soon as possible.

Fiduciary Responsibilities and Investor Communications

• “Assessment, disclosure, and mitigation of conflicts of interest and conduct risk.” EXAMS noted that firms considered conflicts of interests affected by the LIBOR transition, such as cross-trading, principal transactions, and allocation of transition costs.
• “Risk disclosures.” Firms heavily impacted by the LIBOR transition wrote disclosures for risks related to the transition.
• “Information sharing with clients.” Certain firms maintained “frequent and proactive” communication with clients that are heavily exposed to LIBOR transition issues.

Keeping Informed About Ongoing and New Challenges

• Some firms transitioned bank loans before the LIBOR transition deadline.
• EXAMS observed that some complexes found LIBOR-linked contracts that are both overseas and therefore not under the 2021 LIBOR Act’s jurisdiction, and that do not have fallback language nor could transition via an amendment process. EXAMS noted that many such contracts will transition to a synthetic LIBOR.
• Examined firms expected difficulties converting certain LIBOR-linked contracts. EXAMS found that firms advised to continue monitoring industry groups for recommendations on these issues.

What does this mean for me?

Preparation for the Libor Transition has been featured in past Risk Alerts and named among the Exam Priorities since 2020. This latest Risk Alert from EXAMS is a welcome reminder of the reason for that preparation.  If you have not completed your preparation for the LIBOR transition, the observations from EXAMS present the challenges to address while there is still time.

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