Banking and Finance Law Daily Agencies issue FAQs on effect on capital instruments after LIBOR transition
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Friday, July 30, 2021

Agencies issue FAQs on effect on capital instruments after LIBOR transition

By Nicole D. Prysby, J.D.

The FDIC, Fed, and OCC explained that solely replacing a reference rate linked to LIBOR with another reference rate in a capital instrument does not constitute an issuance of a new capital instrument for purposes of the capital rule.

The Federal Deposit Insurance Corporation, Federal Reserve Board, and Office of the Comptroller of the Currency released answers to frequently asked questions (FAQs) addressing the continued regulatory capital eligibility of capital instruments that a bank replaces or amends as a result of the transition from the London Interbank Offered Rate (LIBOR). The guidance explains that the agencies do not consider the replacement or amendment of a capital instrument that solely replaces a reference rate linked to LIBOR with another reference rate or rate structure to constitute an issuance of a new capital instrument for purposes of the capital rule or to constitute creating an incentive to redeem, as long as the replacement or amended capital instrument is not substantially different from the original instrument from an economic perspective (FIL-54-2021SR 21-12OCC Bulletin 2020-32).

On July 29, 2021, the FDIC issued a letter with two answers to frequently asked questions about the impact of LIBOR transitions on regulatory capital instruments under 12 CFR 324. The FDIC posted a summary with highlights. The Board and OCC issued similar question and answer guidance.

Question 1 addresses whether replacing or amending the terms of a capital instrument to transition from the LIBOR to another reference rate or rate structure would be considered an issuance of a new instrument under the capital rule for purposes of the eligibility criteria for regulatory capital. The agencies’ answer is that they do not consider the replacement or amendment of a capital instrument that solely replaces a reference rate linked to LIBOR with another reference rate or rate structure to constitute an issuance of a new capital instrument for purposes of the capital rule. If changes in the terms of the replacement or amended capital instrument solely relate to the adoption of the new reference rate or rate structure, and there are no substantial differences from the original instrument from an economic perspective, the replacement or amended instrument would not be considered a new instrument for purposes of the eligibility criteria for regulatory capital.

Question 2 addresses whether, for purposes of the eligibility criteria for regulatory capital, replacing or amending the terms of a capital instrument to transition from LIBOR to another reference rate or rate structure would be considered creating an incentive to redeem the instrument under the capital rule. The agencies’ answer is that they do not consider the replacement or amendment of a capital instrument that solely replaces a reference rate linked to LIBOR with another reference rate or rate structure to constitute creating an incentive to redeem, as long as the replacement or amended capital instrument is not substantially different from the original instrument from an economic perspective. For example, amending the credit spread solely to reflect the difference in basis between LIBOR and the replacement reference rate and not adjusting for changes in the credit quality of the issuer would not result in creating an incentive to redeem the capital instrument.

The Fed’s supervisory letter also included questions and answers on total loss-absorbing capacity (TLAC) and covered intermediate holding companies (IHCs). The additional guidance materials explain that for purposes of Subpart G of Regulation YY, if a global systemically important bank holding company (GSIB) conducts an exchange of eligible debt securities or amends such securities’ terms in order to replace outstanding debt securities that reference LIBOR with debt securities that contain a substantially equivalent reference rate or other rate structure, and no other changes are made to the debt securities, the replacement or amended debt securities are not considered newly issued debt securities. A GSIB may conduct an exchange or tender offer for securities issued by the top-tier GSIB directly with third party holders in order to facilitate the GSIB’s transition away from LIBOR, if specified conditions are met. Similarly, if a covered IHC exchanges or amends an eligible covered IHC debt security to transition from LIBOR to another substantially equal reference rate or rate structure, that would not be considered an issuance of a new debt security for purposes of the eligibility criteria for the TLAC rule or a continuation of the original eligible covered IHC debt security. A IHC may conduct an exchange or tender offer for securities issued by resolution covered IHC directly with third party holders in order to facilitate the transition away from LIBOR, if specified conditions are met.

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