This blog post is the final installment in a three-part series focusing on the heightened disclosure detail that the SEC is looking for in your corporate filings.
Disclosure review concerning the phaseout of the London Interbank Offered Rate (LIBOR) has been another key 2019 priority for the SEC, especially in light of the potential for business and market disruptions flowing from the expected discontinuation of such a critically important interest rate after 2021 (see my blog post titled Are you ready for the LIBOR transition? for a discussion of LIBOR and the implications of its expected phaseout). SEC Staff, through their guidance and comment letters, discourage generic disclosures that aren’t very helpful for investors, in favor of tailored disclosures regarding risks posed to businesses and operations and actions being taken to address these risks.
LIBOR phaseout disclosure, disclosure, disclosure
The SEC and its Staff have been quite vocal regarding the need for registrants to disclose material company-specific risks and risk-mitigation efforts associated with LIBOR. In July 2019, they issued Staff Statement on LIBOR Transition (available on Thomson Reuters Checkpoint), explaining how the discontinuation of LIBOR may impact specific registrants and providing guidance on how registrants may respond to this risk.
Division of Corporation Finance Staff, for example, emphasize the importance of keeping investors informed about your progress towards material risk identification and mitigation and the anticipated effects on business. Moreover, they urge that you be mindful of the following when crafting LIBOR phaseout disclosures in your Securities Act and Exchange Act registration statements and in your Exchange Act periodic reports:
- Given that the evaluation and mitigation of risks related to the expected discontinuation of LIBOR may span several reporting periods, consider disclosing the status of your related efforts to date and significant matters still to be addressed.
- If you’ve identified a material exposure to LIBOR but do not yet know or cannot yet reasonably estimate the expected impact, consider disclosing that fact.
- Investors are likely to find disclosures that enable them to see you through a management lens most useful. This may involve your sharing information used by management and the board in assessing the impact of the LIBOR transition on your business, such as the notional value of contracts referencing LIBOR and extending past 2021.
Division of Investment Management Staff are also “actively monitoring” the impact of the expected LIBOR phaseout on investment companies (i.e., funds) and advisers, and they ask that you consider the following when describing the material impact of the LIBOR transition on your holdings in your Securities Act and Investment Company Act registration statements:
- Investments without fallback language for when LIBOR is unavailable and those with fallback language that doesn’t contemplate the expected phaseout of LIBOR could become less liquid as the date approaches when LIBOR will no longer be updated, and the related interest rate provisions may need to be renegotiated.
- Whether impact on the liquidity of investments could alter the effectiveness of liquidity risk management programs.
- Closed-end funds and business development companies that engage in direct lending may need to renegotiate terms of contracts extending past 2021 that don’t address the discontinuation of LIBOR.
- Funds that have received exemptive orders referencing LIBOR should consider evaluating implications for terms and conditions of their relief.
LIBOR phaseout disclosures under scrutiny
To help you understand what the SEC expects when it comes to the level of LIBOR phaseout disclosure, below are three such disclosures that were the subject of SEC comments. Each case highlights the company’s original disclosure, the SEC’s comments and the company’s response, and in each one, SEC Staff didn’t raise any issue with the company’s response. This will hopefully help you to model your own disclosures as you evaluate material risks posed by the expected discontinuation of LIBOR.
1) Newtek Business Services Corp. (Post-Effective Amendment to Registration Statement on Form N-2 filed May 16, 2019)
- Original disclosure: “Risk Factors” section covering pages 18 through 49.
- SEC oral comments: “The Company has securitization notes and a Related Party RLOC that are based on LIBOR. Please add a risk factor related to the transition risk involved in LIBOR-based loans.”
- Amended disclosure (see Post-Effective Amendment to Registration Statement on Form N-2 filed July 3, 2019, page 23): The company added the following risk factor:
“To the extent that our securitization notes, Related Party RLOC, and certain investments extend beyond 2021, the interest rates for these obligations might be subject to change based on recent regulatory changes … The interest rates of our securitization notes and Related Party RLOC are calculated using LIBOR.
On July 27, 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, announced that it intends to phase out LIBOR by the end of 2021. It is unclear if at that time whether LIBOR will cease to exist or if new methods of calculating LIBOR will be established such that it continues to exist after 2021. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, is considering replacing U.S. dollar LIBOR with a new index calculated by short term repurchase agreements, backed by Treasury securities. The future of LIBOR at this time is uncertain. If LIBOR ceases to exist, we may need to renegotiate any agreements extending beyond 2021 that utilize LIBOR as a factor in determining the interest rate to replace LIBOR with the new standard that is established, which may have an adverse effect on our ability to receive attractive returns.”
2) Blackstone Real Estate Income Fund (Post-Effective Amendment to Registration
Statement on Form N-2 filed March 12, 2019)
- Original disclosure (Risk Factors, page 59): “Recently, regulators in the United Kingdom (“UK”) have called for LIBOR to be abandoned by the end of 2021. Abandonment of or modifications to LIBOR could have adverse impacts on newly issued financial instruments and existing financial instruments that reference LIBOR. While some instruments may contemplate a scenario where LIBOR is no longer available by providing for an alternative rate setting methodology, not all instruments may have such provisions and there are significant uncertainty regarding the effectiveness of any such alternative methodologies. Abandonment of or modifications to LIBOR could lead to significant short-term and long-term uncertainty and market instability. It remains uncertain how such changes would be implemented and the effects such changes would have on the Fund, the Master Fund, issuers of instruments in which the Master Fund invests and financial markets generally.”
- SEC oral comments provided on April 10, 2019: “On page 59, we note you have added disclosure concerning the 2021 phase-out of LIBOR. Your disclosure briefly touches upon alternative rate setting methodologies as well as the potential for short- and long-term uncertainty and market instability in connection with the transition from LIBOR to the Secured Overnight Financing Rate (“SOFR”). With a view to disclosure, please explain how the Fund is planning for these issues and positioning it in light of market uncertainty. It is unclear, for example, how the Master Fund is monitoring the percentage of its investments that have fallback language and what it believes the implications of not having fallback language would be on its portfolio. Please revise as appropriate.”
- Company response filed April 23, 2019: “As of March 31, 2019, approximately 43.7% of the Master Fund’s investments were floating rate. The Funds have observed that, in the past 18 months, the market has evolved to a point where most loan agreements and MBS floating-rate instruments include relatively standardized fallback language for transitioning to an alternative index (which is defined to be the index that becomes generally used by lenders and other market participants in the mortgage loan industry) and a spread adjustment mechanism to prevent lenders from receiving a lower rate upon transition. The Investment Manager is closely monitoring the progress of the phase-out and checking that appropriate alternative index disclosure is incorporated into their documents, but there is still some uncertainty with respect to how the phase-out will be implemented and what alternative index will be adopted, which will ultimately be determined by the market as a whole. The Funds note that they and the entire industry are evaluating the consequences of LIBOR becoming obsolete and they are poised to react to any developments from the market or regulators concerning this issue.”
3) iShares Trust (Post-Effective Amendment to Registration Statement on Form N-1A filed November 16, 2018)
- Original Disclosure (Risk of Derivatives, page 9): “A derivative is a financial contract, the value of which depends on, or is derived from, the value of an underlying asset, such as a security, a commodity (such as gold or silver), a currency or an index (a measure of value or rates, such as the S&P 500®or the prime lending rate) …”
- SEC oral comments provided on December 27, 2018: “… It is unclear whether the London Interbank Offered Rate (“LIBOR”) will continue to be calculated or published as a reference rate/benchmark after 2021. To address the potential for LIBOR’s cessation, the Federal Reserve Board and the Federal Reserve Bank of New York (FRBNY), in coordination with multiple other regulators and large industry participants, convened the Alternative Reference Rates Committee (“ARRC”). The ARRC has identified the Secured Overnight Financing Rate (“SOFR”) as the preferred successor rate for USD LIBOR. To prepare for a transition from LIBOR to SOFR, the ARRC, the International Swaps and Derivatives Association (“ISDA”), and the Financial Accounting Standards Board (“FASB”) have all taken various steps to develop appropriate fall-back language to address a transition to SOFR that may occur in the future with respect to cash products and derivatives, as well as to provide for hedge accounting … Please provide the appropriate disclosure with respect to the impact of a changeover from LIBOR to SOFR on the Fund’s cash products and its use of derivatives as investments and for hedging. If the Fund’s interfund lending agreements reference LIBOR, please disclose whether they will need to be renegotiated. In addition, please disclose whether the Fund may need to evaluate its existing exemptive relief to determine whether a transition from LIBOR to SOFR or any other fall-back rate affects the terms of its relief.”
- Company response filed February 20, 2019: “The Fund currently does not expect to hold LIBOR-linked derivatives. The Trust confirms that the exemptive relief on which the Fund relies does not reference LIBOR, and the Trust is internally evaluating the impact of changes related to LIBOR and will update the related disclosure if it deems appropriate based on its evaluation.”
Registrants, you should reflect on the above and other SEC comment letters and company responses (available on Thomson Reuters Checkpoint) as you prepare your LIBOR phaseout disclosures. This post concludes the three-part series. Stay tuned for coverage of additional hot topic issues impacting corporate professionals and those responsible for financial reporting disclosures.