Analysis

Libor Transition Plans Could Take Hit From COVID-19 Turmoil

By Jon Hill
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Law360, London (March 17, 2020, 12:43 AM GMT) -- Regulators have been warning the financial industry for months that the end of the London Interbank Offered Rate is coming, but as the coronavirus pandemic bears down on many of the world's major economies, preparations for the transition away from the interest rate benchmark could take a hit.

There are still more than 21 months left until the 2021 deadline for the anticipated cessation of Libor, which is referenced in trillions of dollars in financial instruments but is being phased out after manipulation scandals and concerns about its robustness.

And regulators have insisted that they're determined to see this transition through, telling banks and other financial firms to get their houses in order sooner rather than later. As the president of the New York Fed once put it, the only things guaranteed in life are "death, taxes and the end of Libor."

But as the growing COVID-19 outbreak sends financial markets reeling and raises fears of a deep recession, could the Libor transition and all its attendant legal and technical complexities wind up needing to take a back seat? Financial services attorneys and experts told Law360 that it's early days yet, but it's not out of the realm of possibility depending on how bad things get.

"To be clear, it's not that the virus is infecting the financial system or anything," said Adam Schneider, an Oliver Wyman partner who is co-leading the consulting firm's work advising banks on the Libor transition. "But this is a circumstance where you have the system stressed in ways that it has not been stressed in before, it's not a flood or a power outage. This is new."

Banks are supposed to have contingency plans for keeping themselves up and running in a variety of adverse situations, including in the case of a pandemic. To that end, the Federal Financial Institutions Examination Council released guidance earlier this month outlining how banks should be thinking about pandemic preparedness, updating advice issued more than a decade ago when avian flu threatened.

"A lot of the same considerations apply, but technology is in a different place from where we were in 2006 and 2007," said Dan Stipano, a Buckley LLP partner and former director of the Office of the Comptroller of the Currency's enforcement and compliance division. "As a result of that, I think banks are going to have to have a heightened focus on ensuring that their technology and IT systems work properly."

Ensuring sufficient liquidity and figuring out how to ramp up telecommuting safely and securely are also going to be top of mind for banks as they confront the outbreak, according to Stipano.

"The key for banks is really just planning for worst-case scenarios," Stipano said. "Hopefully, it won't be that bad, but if you plan for that and it plays out, you won't be caught off-guard."

But as the FFIEC noted, the effects of pandemics can be so far-reaching and long-lasting that they can be much tougher to predict and manage. If large swaths of a bank's workforce become too sick to work or must otherwise stay home, for example, the bank could experience significant staffing shortages for weeks at a time that would make it a struggle to keep branches open, process certain transactions and maintain other basic operations.

And given that COVID-19 is shaping up to be a once-in-a-century event, Schneider said the combined challenges of trying to stay operational, meet ongoing regulatory requirements and navigate the pandemic's potential economic fallout could soak up a lot of bandwidth. That means a longer-term initiative like preparing for the Libor transition could get deprioritized at many banks for the time being.

"They will absolutely slow down or suspend many existing projects," Schneider said. "They will have no choice but to do that because running the bank on any given day is more important than most projects."

Still, while Schneider believes it's "distinctly possible" that Libor's expected 2021 end date could be pushed back if the coronavirus pandemic persists long enough that regulators worry about the financial system's readiness for the transition, he said this scenario is "not so imminent that you can make that judgment today."

"Several clients have raised the question of will this be delayed?" Schneider said. "Frankly, it's a little bit of wishful thinking right now. You can't assume a yes. You have to soldier on with the caveat that running the bank, being robust and exercising your business continuity plan are much more important in this particular set of weeks."

Of course, the largest banks, which have been leading the charge on transition planning, don't face the same resource constraints as regional and smaller institutions.

Mark Chorazak, a Cadwalader Wickersham & Taft LLP financial services partner and member of the firm's Libor Preparedness Team, told Law360 that many of these banking giants have put together large teams of personnel dedicated exclusively to Libor transition work, so they would be especially hard-pressed to persuade regulators that they don't have the capacity to forge ahead with preparations at this time.

"Regulators will expect banks to continue on as much as possible," Chorazak said. "There's some struggling as everyone tries to figure out how to do remote work properly, efficiently, smoothly, safely … but I don't see the COVID-19 pandemic, at least right now, as providing an immediate excuse for tabling Libor transition planning."

Going into 2020, regulators were clear that they wanted to see banks making headway on readying themselves for the coming end of Libor. The Office of the Comptroller of the Currency, for example, has said it would step up its oversight of national banks' Libor transition preparations through this year and next, while later this month, New York-regulated banks face a deadline to tell New York's Department of Financial Services how they plan to manage the risks of the transition.

But depending on how much additional stress the pandemic puts on the financial system in the next two quarters, Chorazak said banking regulators could feel compelled to dial back their expectations for planning progress.

"Some accommodation is likely if there's a collective expression of unease by the largest banks. We're in such uncharted territory that the agencies are probably going to have to be sensitive to that," Chorazak said.

One way the regulators could do this is by softening the tone of their messaging to the industry.

"Where they could be helpful is in expressing support for institutions, recognizing that this is a challenging time and encouraging active engagement," Chorazak said.

In his view, supportive statements are far more likely than an outright delay of the 2021 deadline in part because the regulators don't see Libor's phase-out as a top-down process that's up to them to control. Instead, they see it as a market-led change that must build and maintain momentum in order to achieve success.

Schneider noted that any change to the deadline itself would also have to involve the U.K., which oversees Libor through the Financial Conduct Authority. In 2017, the FCA effectively set the deadline when it announced it would withdraw official support for the benchmark after the end of 2021.

But short of that, he said modifications could be made to some of the intermediate steps along the anticipated timeline for the transition in the U.S., such as the dates when certain segments of financial products are supposed to switch over to an alternative benchmark and leave Libor behind.

"There are things that could readily be done to extend the time frame or simplify some of the work, especially around fallback details," Schneider said.

In the U.S., a Federal Reserve-convened committee of public sector and private market participants has endorsed the Secured Overnight Financing Rate, or SOFR, as the preferred alternative benchmark for U.S. dollar Libor.

But while SOFR is supposed to be superior to Libor in certain respects, there have been concerns that it's ill-suited for use as a reference rate in lending because of how it could behave during periods of economic stress. And with the pandemic poised to put an unknowable amount of stress on the economy, those concerns could take some more time for financial institutions to work through.

"SOFR is a backward-looking rate, whereas Libor is a forward-looking rate, and in a time like this, there's a vast difference in those two kinds of rates," said Carolyn Alford, a King & Spalding LLP partner who leads the firm's finance practice. "People will think back on this and really want to evaluate how SOFR might need to be adapted to be able to handle disruptive events like this."

Yet if economic conditions haven't stabilized by the time the 2021 deadline for Libor cessation draws nearer and the industry shows strong signs of unease about adopting SOFR amid the turmoil, Chorazak said he expects the regulators won't just barrel ahead full speed in pushing for the transition.

"They would be concerned about the larger economy and the performance of SOFR," Chorazak said. "They have every desire to make sure that this transition succeeds by having an alternative rate that's accepted by the market."

--Editing by Emily Kokoll and Kelly Duncan.

For a reprint of this article, please contact reprints@law360.com.

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