On Tuesday, the Fed published supervision letter SR 21-7 to assist examiners in their assessment of firms’ progress in the transition away from LIBOR. The letter outlines the same six assessment dimensions – 1) transition plan; 2) exposure measurement and risk assessment; 3) operational preparedness; 4) contract preparedness; 5) communication; and 6) oversight – for firms with less than $100 billion in assets and for firms with more than $100 billion in assets with more robust expectations for preparedness at larger institutions.
The letter is applicable to all firms supervised by the Fed, including foreign banking organizations (FBOs). As part of ongoing monitoring, banks can specifically expect questions on budgets, exposure monitoring, resources and contingency planning for operational readiness to transact in alternative reference rates. Placing emphasis on program oversight, the guidance calls for regular reporting on transition progress to senior management and the board of directors. FBOs with total US assets exceeding $100 billion will be expected to provide progress reports that contextualize LIBOR exposures in comparison to those of the foreign parent to the US Chief Risk Officer and the US Risk Committee. Similar to interagency guidance on the use of USD LIBOR in new contracts released late last year, the Fed suggests that a lack of progress in transitioning away from LIBOR could create safety and soundness risks not just for individual firms but for the financial system as a whole. Examiners are asked to consider taking direct supervisory action in cases where a firm does not appear prepared to cease the issuance of new USD LIBOR products no later than December 31, 2021.
The Fed’s letter comes on the heels of the UK Financial Conduct Authority’s (FCA) formal announcements on the future cessation and loss of representativeness of all LIBOR benchmarks last Friday. Those announcements confirmed the cessation or “loss of representativeness” for GBP, EUR, CHF and JPY LIBORs at the end of this year, with the most widely used tenors of USD LIBOR being published until the end of June 2023. However, regulators in the US, UK and other jurisdictions have made it clear that any representative or “synthetic” LIBOR setting, i.e. a rate no longer relying on panel bank submissions, still published after 2021 would solely be available for reference by legacy LIBOR-based contracts. After the end of 2021, no setting of the five currency LIBORs will be widely available for use in new contracts.
The Fed’s expectations should not come as a surprise as they closely align to previous regulatory guidance as well as publications by the Alternative Reference Rate Committee (ARRC) and other industry groups. However, there are some aspects of the letter that highlight the unique challenges of the LIBOR transition, reiterating that firms need to intensify their transition efforts – in some cases significantly so. An explicit expectation for larger institutions that senior management “provide appropriate budget and personnel resources to support implementation of the [LIBOR transition] plan and to avoid timeline delays” is a clear message from the Fed that it expects firms to take the transition seriously. The 2021 year-end deadline for cessation of new LIBOR issuances is approaching quickly, and a lack of budget or resources will not be an acceptable excuse for large firms to be unprepared.
It is also noteworthy that the supervisory letter advises firms that it is their responsibility to prepare for any number of what-if scenarios. While a focus on planning is not unusual, the explicit reference to contingency planning follows growing regulatory emphasis on operational resiliency. Firms have faced operational dependencies in readying themselves for the LIBOR transition and they need to have contingencies for delays or complications. For example, a number of firms’ transitions have been dependent on the implementation of vendor enhancements to address risk-free rate (RFR) product conventions and the need to enhance models and complete technology assisted evaluation of contractual terms. Some firms have also adopted a “wait and see” approach in anticipation of a forward-looking SOFR term rate. However, the supervisory letter makes it clear that firms need to advance their preparations while accounting for uncertainty rather than depending on outside factors.
Firms found by examiners to be lagging in their preparations for LIBOR transition should expect to receive additional attention from regulators over the remainder of 2021. The prospect of enforcement actions should make one thing very clear: firms can expect regulators to hold steadfast in their expectation that firms meet the target date of December 31, 2021 for an end to new issuances referencing USD LIBOR. In reality, considering the ARRC’s best practices target date of Q2 2021 for an end to new LIBOR business loans, securitizations (excluding CLOs) and derivative trades that increase LIBOR risk, firms should plan to complete the move to new alternative reference rates long before the end of the year. Read their lips: No new LIBOR.
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The last two weeks have seen a number of notable developments related to climate risk and other environmental, social and governance (ESG) issues:
● DOL will not enforce ESG investment rule. On Wednesday, the Department of Labor (DOL) announced that, pending further guidance, it will not enforce a final rule issued last November that calls for retirement account managers to focus on returns rather than ESG factors as investment criteria. That rule requires asset managers to select investments based solely on factors that have a material impact on risk or returns, and it specifies that ESG issues do not constitute such factors unless they can be proven to have a direct financial impact. In this week’s announcement, the DOL explains that it intends to revisit the rule to better recognize the role that ESG factors can play in investments while continuing to uphold fiduciary obligations.
● White House holds climate finance meeting. On Tuesday, the White House convened a meeting between National Economic Council (NEC) Director Brian Deese, National Climate Advisor Gina McCarthy, and leaders focused on climate-related financial risks. The readout of the meeting indicated support for greater transparency around climate-related risks and a commitment to “promoting the flow of capital toward climate-aligned investments.”
● SFDR takes effect. This week, the first requirements under the EU’s Sustainable Finance Disclosure Regulation (SDFR) came into effect. The SDFR requires financial institutions to disclose how sustainability considerations are incorporated in their decision making and remuneration policies as well as the adverse impact of investment decisions on ESG factors. It also requires that they make product-level disclosures - particularly for those products which promote environmental or social characteristics or have ESG as a specific objective. They will also have to periodically report product-level disclosures by January 1, 2022 based on technical specifications which had their most recent version issued for consideration by the European Council last month.
● EBA proposes ESG metrics. Last week, the European Banking Authority (EBA) issued a proposal for metrics and qualitative information to be disclosed by financial institutions to indicate the environmental sustainability of their activities. One of the metrics proposed is a green asset ratio (GAR) showing the percentage of institutions’ financing activity that supports sustainable activities per the EU Taxonomy Regulation.
Issued quickly in the final days of the Trump Administration and met with opposition from Congressional Democrats, sustainable investment groups, and a large number of asset management firms, the DOL rule was an obvious item on the chopping block considering the new Administration’s focus on ESG. While the non-enforcement policy does not formally end the rule, we do not expect it to return. Any future regulation or guidance from this Administration on the subject will likely provide transparency on acceptable ESG investing practices that are in line with fiduciary obligations. In the meantime, however, the rule remaining in place opens the door for private litigation for noncompliance, so retirement plan managers may wish to tread carefully until further announcements are made.
Meanwhile, in the EU, it is clear that ESG investment is far from discouraged - as long as it’s accurately and transparently advertised. The influx of disclosure requirements is not only meant to increase transparency and standardization in ESG products but to ultimately stimulate changes in the allocation of capital to more sustainable activities and investments. Although periodic SFDR reporting is still at least a year away, and a potential GAR is still in the proposal stage, firms marketing ESG products should be organizing and preparing their data by documenting relevant sources, data flows and reporting processes and extending governance oversight to cover ESG disclosures. They will also need to continue growing their ESG expertise as disclosure obligations evolve and questions around adverse impact become more nuanced. US firms with global operations have already started to comply with SFDR for their EU subsidiaries or products marketed in the EU, but they, and other US firms, should consider working towards SFDR standards in preparation for eventual US requirements. Given the interconnected nature of the financial services industry, the EU rules could become the industry standard for firms that operate on a global scale and provide a model for the US regulators to adopt.
For more on recent regulatory activity related to climate risk and how financial institutions should be responding, see Green light: FS warms up to climate risk.
These notable developments hit our radar over the past week:
● Stimulus signed into law. Yesterday, President Biden signed into law a $1.9t stimulus bill that passed the Senate and House with a slim Democratic majority. The bill includes $1400 direct payments, $350 billion for state and local governments, an increase in child tax credits for low- and middle-income families, $160 billion for vaccination and testing, moratoriums on foreclosures and evictions, and expanded unemployment assistance. Treasury Secretary Janet Yellen issued a supportive statement including her belief that this stimulus could help the economy reach full employment as soon as next year.
● Nominations. Yesterday, the White House announced the nomination of Nellie Liang for Under Secretary of Domestic Finance, where she is expected to play a key role in financial regulation and housing policy issues. She previously served as the Fed’s first Director of the Division of Financial Stability from 2010 to 2017 and helped craft post-2008 crisis financial regulations. On the same day, the Senate Banking Committee voted to advance the nominations of Gary Gensler for SEC Chair and Rohit Chopra for CFPB Director to the full Senate. Gensler was advanced with a vote of 14-10 and Chopra was advanced with a party-line 12-12 vote.
● CFPB rescinds “abusive” definition. Yesterday, the CFPB announced that it is rescinding a policy statement released last year, explaining that the statement restricted the agency’s ability to protect consumers by narrowing its enforcement abilities and limiting monetary penalties.
Financial Services Leader, PwC US