SEC issues additional LIBOR guidance for market participants
Statement reminds public companies, broker-dealers, investment advisers and investment funds of their disclosure and other obligations
While recent headlines on corporate disclosure have focused on environmental, social and governance issues, new guidance issued by the U.S. Securities and Exchange Commission (“SEC”) is an important reminder to public companies that the SEC staff is still paying close attention to disclosure regarding the transition from the London Interbank Offered Rate (“LIBOR”).
The guidance, SEC Staff Statement on LIBOR Transition—Key Considerations for Market Participants, reminds public companies, issuers of asset-backed securities and others of their disclosure obligations related to the LIBOR transition. It also addresses broker-dealers’ legal obligations when recommending LIBOR-linked securities and when underwriting primary offerings of municipal securities or recommending municipal securities; investment advisers’ legal obligations when recommending LIBOR-linked securities or otherwise providing advice regarding other LIBOR-linked investments; and funds and investment advisers’ obligations related to disclosure, valuation, and operational issues.
Disclosure considerations for public companies
The guidance states that public companies must keep investors informed about their progress toward LIBOR risk identification and mitigation, and the anticipated impact on the company, if material. The SEC staff urges companies to provide detailed and specific disclosure, rather than general statements about the progress of the company’s transition efforts to date.
Among other things, the guidance says:
- Companies should provide qualitative disclosures and, when material, quantitative disclosures, such as the notional value of contracts referencing LIBOR and extending past December 31, 2021 or June 30, 2023, as applicable, to provide context for the status of the company’s transition efforts and the related risks.
- Companies with material risk related to outstanding debt with inadequate fallback provisions should consider disclosing how much debt will be outstanding after the relevant cessation date and the steps the company is taking address the situation, such as renegotiating contracts or refinancing the obligations.
- To the extent that a company has or is taking steps to identify and assess LIBOR exposure and mitigate material risks or potential impacts of the transition, the company should consider providing investors insight into what the company has done, what steps remain, and the timeline for further efforts.
- Companies subject to bank supervisory guidance should consider providing detailed disclosure about their transition efforts and the impact of the efforts on the company, if material. Banking regulators have provided guidance to their regulated entities encouraging those banks “to cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021.”
Companies typically include disclosures about the LIBOR transition as part of risk factors, recent developments, management’s discussion and analysis and/or quantitative and qualitative disclosures about market risk. The guidance suggests that to the extent a company provides LIBOR transition disclosure in response to more than one disclosure requirement within a filing, it should consider providing a cross-reference or otherwise summarizing or tying the information together so an investor has a complete and clear view of the company’s plan for the discontinuation of LIBOR, the status of the company’s efforts, and the related risks and impacts.
For further guidance on disclosure considerations, companies should continue to refer to the LIBOR guidance that the SEC staff issued in 2019.
Guidance for broker dealers
Given the announced discontinuation of the one-week and two-month USD LIBORs at the end of this year and the remaining USD LIBORs to be discontinued in 2023, the guidance also urges broker-dealers to be especially mindful of their obligations when recommending LIBOR-linked securities or investment strategies involving LIBOR-linked securities to retail customers. As a threshold matter, a broker-dealer should carefully consider whether the securities or investment strategies it recommends to customers include LIBOR-linked securities, including securities with underlying investments in LIBOR-linked financial instruments.
For example, when making a recommendation of a LIBOR-linked security or investment strategy involving LIBOR-linked securities to retail customers, a broker-dealer should understand whether the LIBOR-linked security has robust fallback language in its offering documents or prospectus that includes a clearly defined alternative reference rate after LIBOR is no longer available, as well as the impact of that replacement rate on the expected performance of a LIBOR-linked security, to have a reasonable basis to believe that the recommended security is in a particular retail customer’s best interest. The guidance specifically states that given the now-certain transition away from LIBOR as a reference rate, it would be difficult for a broker-dealer to satisfy Regulation Best Interest’s care obligation where it recommends a LIBOR-linked security with no fallback language absent the recommendation being premised on a specific, identified, short-term trading objective.
The guidance also addresses the impact the expected discontinuation of LIBOR may have on broker-dealers that underwrite, trade or otherwise effect transactions in municipal securities.
Guidance for investment advisers and funds
Investment advisers are directed to consider whether any advice regarding LIBOR-linked investments and applicable risks is consistent with their clients’ goals. The guidance states that because the cessation of LIBOR is likely to materially change the nature of certain investments, unless the adviser does not have an obligation to monitor, advisers should consider whether any LIBOR-linked investments they have recommended that clients purchase or continue to hold remain in the best interest of those clients. Among other things, investment advisers should consider whether those investments or related contracts have robust fallback language providing for an alternative rate when LIBOR is no longer published or ceases to be representative of its underlying market. Where fallback language references an alternative rate, advisers should consider whether any economic differences arising from the application of the alternative rate could cause the investment to depart from their clients’ strategy or risk tolerance.
The guidance also reminds registered investment companies and business development companies of their disclosure obligations with respect to LIBOR. For example, if a fund invests a significant portion of its assets in LIBOR-linked investments, it should disclose any principal risks related to the potential cessation of LIBOR, as well as the anticipated impact (and expected timing of that impact) on those investments, including with respect to volatility, value, and liquidity.
Funds and advisers should also monitor and manage any conflicts of interest associated with the transition, including, for example, by considering their disclosure and other legal obligations relating to performance fees. Investment advisers and funds should be mindful that the transition away from LIBOR also introduces operational complexities that may require market participants (including investment advisers, funds and their key service providers) to make significant changes to their operational processes and IT systems, which could take a significant amount of time to complete.
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We will continue to monitor developments in this area and encourage you to contact us if you have any questions about disclosure and other issues relating to the transition from LIBOR.