Municipal issuers and market participants with exposure to LIBOR should review potential risks and consider appropriate disclosures to the market.
The transition from the London Interbank Offered Rate (“LIBOR”), the reference rate utilized in countless financial instruments, to one or more new reference rates, will be completed over the next few years. Like all epic road trips, the LIBOR transition started with a burst of energy and excitement and a clear view of the destination in mind.
There were a few detours and difficulties along the way, however.
Recently, the end of the road has come into view, as discussed more below.
To assist municipal market participants in managing the transition away from LIBOR, staff from the SEC’s Office of Municipal Securities (“OMS”) recently issued a statement (the “OMS Statement”) containing guidance to municipal market participants regarding disclosure of potential risks related to the transition. As described in the OMS Statement, municipal market participants should proactively assess the impact of the LIBOR transition on new and existing financings and take appropriate steps to ensure the discontinuation of LIBOR does not adversely impact a municipal issuer’s or obligor’s debt payment obligations or financial position.
Background on LIBOR Transition
The discontinuation of LIBOR has been evolving since 2017 when the United Kingdom’s Financial Conduct Authority first called for LIBOR to be phased out by 2021. Currently, ICE Benchmark Administration (the publisher of LIBOR) plans to discontinue publication of the one-week and two-month LIBOR on December 31, 2021, and to discontinue publication of overnight, one-month, three-month, six-month, and twelve-month LIBOR on June 30, 2023. In October 2020, the International Swaps and Derivatives Association announced fallback language for derivative contracts incorporating SOFR (the Secured Overnight Funding Rate, published by the Federal Reserve Bank of New York), as well as a process by which counterparties to such contracts could elect to apply the fallback language to existing derivatives on or after January 25, 2021. SOFR was identified by the Alternative Reference Rates Committee, a group of private-market participants convened to help ensure a successful transition from LIBOR in the United States, as the recommended replacement to LIBOR in the United States. The adoption of the fallback protocols does not change the index for subject swap agreements from LIBOR to SOFR, but simply creates the legal framework for that to occur in the future.
Libor Transition Disclosure Considerations
OMS staff recommends that municipal issuers and obligors consider the need to make appropriate disclosures regarding the risks related to the planned discontinuation of LIBOR. In offering documents, issuers and obligors should consider disclosure of any risks associated with LIBOR relating to the offered securities or other financial transactions of the issuer that may be material to investors. OMS staff also encourages issuers and obligors to consider secondary market disclosure for existing financings about the LIBOR transition to keep investors informed, whether through required or voluntary disclosures.
As the pace of the LIBOR transition accelerates, municipal market participants should review the LIBOR exposure of their organizations and work with advisors to ascertain and mitigate risks associated with the transition. In addition, market participants should consider the importance of LIBOR transition risks to existing investors and craft appropriate disclosure regarding material risks and steps taken to mitigate such risks. Primary risks highlighted in the OMS staff statement include (a) difficulties in amending existing contractual arrangements, including debt instruments, to replace LIBOR-based rates before LIBOR is no longer published, (b) tax impacts of amendments to existing financial arrangements, and (c) the impact of the discontinuation of LIBOR on long-term hedging strategies that depend on LIBOR for the hedge to be effective. In these circumstances, market participants should take a proactive approach to ascertaining LIBOR exposure and take steps to avoid unanticipated increases in debt costs or adverse impacts to hedging strategies.
Municipal Advisors and LIBOR Transition Risks
OMS staff advises municipal advisors to consider issues and risks arising from the LIBOR transition in the context of any transactions involving LIBOR-based instruments. The statement highlights municipal advisors’ duty to have a reasonable basis to believe a transaction or product is suitable for its client under MSRB Rule G-42 and municipal advisors’ fiduciary duty under Section 15B(c)(1) of the Securities Exchange Act of 1934. The OMS staff statement also notes a recent LIBOR risk alert from the SEC’s Division of Examinations that may be relevant to municipal advisors.
While there will likely be a few more twists and turns before we see LIBOR depart the municipal market, issuers, borrowers, and other market participants should disclose potential risks and start to take action now to mitigate any potential problems resulting from the eventual change.