An updated self-assessment tool to aid banks in their transition from a soon-to-be-defunct reference rate was published Monday by the national bank regulator.
In its Bulletin 2021-46, the Office of the Comptroller of the Currency (OCC) said the updated tool, which helps banks abandon the London Interbank Offered Rate (LIBOR) by the time it ceases at year-end, is aimed at evaluating bank preparedness to deal with the end of the rate. In particular, the agency said, the tool can help banks evaluate their management processes for identifying and mitigating LIBOR transition risks.
The agency said it expects banks to cease entering into new contracts that use LIBOR as a reference rate “as soon as practicable” and no later than Dec. 31, 2021.
In particular, the agency said, management should tailor the bank’s risk management process to the size and complexity of the bank’s LIBOR exposures. For example, the OCC said, large or complex banks and those with material LIBOR exposures should have a robust, well-developed transition process in place. Small or non-complex banks and those with limited exposure to LIBOR-indexed instruments can consider less extensive and less formal transition efforts.
“Bank management should consider all applicable risks (e.g., operational, compliance, strategic, and reputation) when scoping and completing LIBOR cessation preparedness assessments,” the agency said.
When assessing preparedness to end reliance on LIBOR, the OCC said, banks should consider whether its transition progress is sufficient. “LIBOR exposure and risk assessments and cessation preparedness plans should be complete or near completion with appropriate management oversight and reporting in place,” the regulator said.
It added that most banks should be working toward resolving replacement rate issues while communicating with affected customers and third parties, as applicable.
In other comments, the OCC said it shared the view of the International Organization of Securities Commissions (IOSCO), voiced in September, that some of LIBOR’s shortcomings may be replicated through the use of credit-sensitive rates that lack sufficient underlying transaction volumes (one of the key reasons that LIBOR has been discontinued).
The OCC noted that banks must select LIBOR replacements that are robust, resilient, and reliable at all times, particularly in times of market stress. “The OCC expects banks to demonstrate that their LIBOR replacement rates are robust and appropriate for their risk profile, nature of exposures, risk management capabilities, customer and funding needs, and operational capabilities,” the agency stated.
In particular, the OCC pointed out that the IOSCO has noted that the Secured Overnight Financing Rate (SOFR) – developed by a Federal Reserve-sponsored group – “provides a robust rate suitable for use in most products, with underlying transaction volumes that are unmatched by other alternatives.”
The agency underscored that while banks may use any replacement rate they determine to be appropriate for their funding model and customer needs, OCC supervisory efforts will initially focus on non-SOFR rates.
When assessing a replacement rate, OCC said bank management should evaluate whether:
- the rate always reflects competitive forces of supply and demand and is anchored by a sufficient number of observable arm’s-length transactions, during all market conditions including periods of stress;
- the rate’s underlying historical data are extensive, spanning a variety of economic conditions;
- the rate’s administrator maintains durable methodology and governance processes to ensure the quality and integrity of the benchmark through periods of market stress;
- the rate’s transparency provides market participants the ability to understand the methodology, permitting them to independently substantiate the rates published;
- the market for financial instruments that use the rate is sufficiently liquid to allow for the effective management of market risk.
“Bank management should continually monitor the rates it uses for uninterrupted availability,” the agency stated. “If future circumstances limit any rate’s availability, it may be necessary for bank management to change affected contracts to a different rate. New or modified financial contracts should have fallback language that permits efficient rate replacement that is clearly identified in the contractual terms. Management should have an internal process to assess a rate’s availability and to prepare the bank to transition to a different reference rate if necessary.”