FINANCIAL INTERMEDIARIES—SEC Division of Examinations issues preparedness observations in advance of LIBOR cessation date - 17 May 2023

LIBOR-Transition preparation efforts varied considerably depending on the type and amount of LIBOR exposure, with most firms examined having significant direct exposure to LIBOR-linked contracts, and a few with large retail client bases having more limited and indirect exposure.

The SEC’s Division of Examinations has issued a Risk Alert identifying its observations from examinations conducted at investment firms concerning LIBOR-transition preparedness. With the U.S. Dollar LIBOR (formerly the London Interbank Offered Rate,) scheduled to be discontinued after June 30, 2023 (cessation date), the Division undertook a series of examinations to assess registrants’ preparedness for the cessation of LIBOR. The Alert focuses on exams of registered investment advisers and investment companies and is intended to remind firms of the transition as well as summarize some observations gleaned from the recent examinations.

Types of firms reviewed. With the LIBOR-transition cessation date looming in less than 2 months, the Division examined investment firms categorized as: (i) advisers associated with large bank complexes; (ii) advisers to various types of registered investment companies (i.e., mutual funds, closed-end funds, exchange-traded funds, and business development companies); (iii) small, medium, and large fund complexes; (iv) advisers to private funds that invest in private credit, such as collateralized loan obligations; and (v) large retail-oriented advisers.

Risk Management practices implemented. Although the examiners found that firms’ preparation efforts varied considerably depending on the type and amount of LIBOR exposure, most of the examined firms had significant direct exposure to LIBOR-linked contracts. A few, which had large retail client bases, had more limited and indirect exposure. The Staff observed certain risk management practices firms have implemented to address the transition away from LIBOR including the following:

• Treatment of transition as an enterprise risk governance matter. Firms with significant exposures have formed cross-functional LIBOR transition working groups, often overseen by a risk governance committee. They have also created transition plans complete with work streams and timelines, and have completed comprehensive impact assessments on investment and operational exposures.

• Keeping informed and engaged in industry associations. Almost all examined firms are either members of the Alternative Reference Rates Committee (ARRC) or rely on its guidance, and several are participating in LIBOR-transition discussions with relevant industry groups.

• Internal training and guidance. Firms have made efforts to ensure that traders, portfolio managers, and client-facing representatives are kept informed and up-to-date concerning the LIBOR-Transition and internal policies, procedures or guidance.

Operations practices adopted. Many firms were found to have actively engaged with service providers, sub-advisers, and third-party managers, and, worked extensively with fund administrators and pricing or data providers to understand their transition readiness.

In addition, firms that require internal system updates had performed end-to-end testing to confirm that their systems can accommodate alternative reference rates (ARRs) currently used, or that will be used post-transition. Several firms also employed rigorous reconciliation processes, aimed at ensuring that all terms and conditions of the ARRs were properly accounted for.

Gauging LIBOR exposures. Many firms took a global approach to contract identification, looking broadly at LIBOR exposure across subsidiaries and affiliates. Most firms either created or utilized internal tools to track and monitor LIBOR and ARR exposure on a real-time or periodic basis.

Several firms also used third-party service providers with specialized skills in document review to identify fallback provisions, and, to proactively assess risks associated with the various fallback provisions, or lack thereof. Firms further considered what, if any, trading restrictions to place on new and legacy LIBOR-linked instruments and communicated their approaches to the relevant personnel. Although some instruments may not be susceptible to early transition, firms have been converting to ARRs where practicable and urging counterparties to convert ahead of the Cessation Date.

Conclusions. The Risk Alert concluded that the firms examined have made significant efforts to prepare for the transition away from LIBOR, implementing a variety of practices depending on their business models and client base. Additionally, the Staff noted that several challenges exist to a smooth and orderly transition away from LIBOR, and the Division encourages all firms to be aware of such issues, including consideration of the resources necessary to address them, and to act consistent with their fiduciary obligations as they continue in the transition process.

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