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April 27, 2023

It’s hard to believe that, after more than six years, we can actually see the LIBOR finish line.

My esteemed colleague, Lary Stromfeld, has been banging drums from the outset and has certainly earned his market-leading reputation with his critically important work guiding the Federal Reserve ARRC, his drafting of New York State and federal LIBOR legislation, his counsel to many of our leading financial services clients, his thought leadership and his management of our LIBOR Preparedness Team.  

Lary has two items in today’s Cabinet News and Views − an update on the ARRC’s recent activities and an article on LIBOR he wrote for IFLR. Both are must reads as we get closer to the end of LIBOR as we know it.  

Lots more to read about this week. And by way of coming attractions, we are taking an in-depth look at the FSOC proposals on an analytic framework for financial stability risks and nonbank financial company determinations, and will have that out for next week’s edition. Also judging from the news out of Washington, it sounds as if we will be looking at the Federal Reserve’s (and possibly the FDIC’s) supervisory post-mortems on last month’s bank failures, and will provide thoughts on those next week as well.    

For now, please reach out here if there’s anything you’d like to talk about.   

Daniel Meade 
Partner and Editor, Cabinet News and Views

Profile photo of contributor Lary Stromfeld
Partner | Financial Regulation

The Alternative Reference Rates Committee (ARRC) announced three updates to its recommendations for the use of Term SOFR. 

First, the ARRC clarified the scope of “business loans” that may be hedged with Term SOFR swaps. Second, the revised recommendations recognize that end users may enter into Term SOFR basis swaps even when they do not have exposure on Term SOFR cash assets. Third, the ARRC clarified when the liabilities (i.e., the securities) issued in a securitization could use Term SOFR.

The announcement first differentiated between “business loans” (for which Term SOFR may be appropriate) and intercompany loans (for which the recommendation remains 30- or 90-day SOFR in advance). A Term SOFR swap may be used to hedge a business loan that is primarily for a business or commercial purpose. The announcement gives several itemized examples, including a syndicated loan or trade finance transaction. The recommendation does not include business loans that are securities offered publicly or in 144A transactions or securities sold in private transactions unless, in the latter case, it is the “functional equivalent” of a loan that would otherwise be within scope of the recommendations. This last point tries to capture certain syndicated business loans irrespective of their treatment for certain regulatory purposes.

The announcement also expanded the market for Term SOFR derivatives by recognizing that dealers could enter into Term SOFR-SOFR basis swaps with end users who are not hedging their exposure on a Term SOFR cash product (which was the case in the ARRC’s earlier recommendations). The ARRC was very clear that the broader recommendation did not cover either end users entering into Term SOFR derivatives that are not basis swaps or dealers entering into any Term SOFR derivatives with other dealers. Rather, this narrow expansion is intended to address “concerns that dealers may eventually build up positions that are so large as to render them unable to warehouse further additional Term SOFR exposures.”

Finally, the ARRC recognized that Term SOFR could be used for the securities issued by a securitization that holds Term SOFR assets so that the cashflows would be better matched. However, “after these transition issues are past,” the ARRC would not recommend the use of Term SOFR “in a situation in which a securitization’s Term SOFR liabilities have been structured at issuance to materially exceed the anticipated cash flows from the portion of floating rate assets (which would be expected to be predominantly Term SOFR assets) in the securitization.”

In a related development, the licensing agreement for use of CME Term SOFR is expected to be revised to be consistent with these updated ARRC recommendations, thus making such limitations a part of the contract under which market participants may use CME Term SOFR.

Since Andrew Bailey, then CEO of the UK’s Financial Conduct Authority, fired the starting gun in July 2017, regulators and market participants around the world have been planning for the end of LIBOR, which will now occur in less than 10 weeks. For many, this is the final leg of a marathon that has included many legal, economic and operational hurdles. For others, this will be an all-out sprint to the finish line. This article, originally published in IFLR, lays out some of the many considerations to meet the challenge of transitioning legacy contracts away from U.S. dollar LIBOR. Read it here.

Profile photo of contributor Daniel Meade
Partner | Financial Regulation
Profile photo of contributor Mercedes Kelley Tunstall
Partner | Financial Regulation

The Office of the Comptroller of the Currency (“OCC”) and the Federal Deposit Insurance Corporation (“FDIC”) (collectively, the “Agencies”) provided supervisory guidance this week on certain overdraft practices. Of particular focus are “Authorize Positive, Settle Negative” (“APSN”) practices.

Prior to this guidance, banks were generally allowed to use their own judgment to ascertain when a particular overdraft charge would apply to transactions coming in, as long as they disclosed their methodology to consumers. However, many institutions have found − usually through customer complaints or lawsuits − that consumers are regularly confused by the methodology disclosures. 

Accordingly, APSN transactions, as the name suggests, are transactions where a customer has sufficient account balances at the time the transaction is initiated (e.g., a debit card transaction at a point of sale), but as other transactions are processed, the authorized transaction settles against a negative balance. The guidance highlights that some institutions will assess an overdraft fee on the APSN transaction and the intervening transactions that exceed the customer’s account balance. 

The agencies noted that they have “determined that certain overdraft practices related to APSN transactions were unfair” in their consumer compliance examinations. The Agencies went on to note that if a bank fails to take steps to avoid assessing overdraft fees for APSN transactions, then such failure “results in heightened risk of violations of the unfair, deceptive or abusive acts or practices (“UDAAP”) provisions of the Dodd-Frank Act, and the unfair and deceptive acts and practices (“UDAP”) provision of Section 5 of the Federal Trade Commission Act.

The Agencies encouraged institutions to review their overdraft practices for APSN charges. As this guidance indicates, many institutions have already made changes as a result of supervisory compliance examinations. In doing so, these institutions have had to employ a multi-pronged approach to identifying APSNs that includes human review, because it is not always obvious when they have occurred. 

The Agencies also encouraged “review [of] disclosures and account agreements to ensure the financial institution’s practices for charging any fees on deposit accounts are communicated accurately, clearly, and consistently.” The Agencies concluded, however, that in their view, “disclosures generally do not fully address Dodd-Frank UDAAP and FTC UDAP risk associated with APSN transactions and related overdraft fees.” 

As we go to press, the Federal Reserve Board (“FRB”) did not issue similar guidance this week. The FRB may yet issue similar guidance, or may feel they have already addressed the issue. As FRB Governor Michelle Bowman noted in a speech last month, the FRB has focused on this issue since at least 2018.  

The Consumer Financial Protection Bureau (“CFPB”) issued a circular last year indicating that they viewed APSN charges as likely to be an unfair act or practice for purposes of the Consumer Financial Protection Act. The circular provides an in-depth explanation of how overdraft fees tied to APSNs may end up being unfair to consumers.

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