LIBOR Transition Information
The MSRB is publishing this information regarding the LIBOR reference rate and encouraging regulated entities to review their activities related to LIBOR transactions, particularly given that the financial authority responsible for the publication of LIBOR has stated that it cannot guarantee that the LIBOR reference rate will be published beyond 2021.[1] This information is intended to highlight existing MSRB rules that promote the protection of municipal entities by ensuring they are apprised of risks associated with the LIBOR reference rate when entering into new LIBOR-based transactions. [2]
Background
The Alternative Reference Rates Committee (ARRC) is a group of private-market participants convened by the Federal Reserve Board and the New York Fed to help ensure a successful transition from LIBOR to a more robust reference rate. The ARRC has observed that, “[t]he transition from LIBOR is important because the potential disruption or cessation of LIBOR poses a financial stability risk as well as a risk to the individual firms with LIBOR exposures.”[3] The ARRC’s website can be accessed here. Similarly, Chairman Jay Clayton of the U.S. Securities and Exchange Commission (SEC) has expressed concerns about the risks posed to municipal market participants by the LIBOR transition. He has stated, “. . . the pending transition away from LIBOR as a benchmark reference rate presents risks that market participants, including municipal entities, need to address.”[4]
Underwriters’ Fair Dealing Obligations
The MSRB reminds brokers, dealers and municipal securities dealers (collectively, “dealers”) of their fair dealing obligations related to any new LIBOR transactions. Under MSRB Rule G-17, on conduct of municipal securities and municipal advisory activities, dealers must, in the conduct of their municipal securities activities, deal fairly with all persons and must not engage in any deceptive, dishonest, or unfair practice.
The MSRB has previously stated that transactions benchmarked to a LIBOR index can constitute a “complex municipal securities financing” and that “an underwriter in a negotiated offering that recommends a complex municipal securities financing to an issuer has an obligation under Rule G-17 to make more particularized disclosures than those that may be required in the case of routine financing structure.”[5] Among other requirements, these more particularized written disclosures require the underwriter to disclose to the issuer the material financial characteristics associated with a LIBOR transaction, as well as the material financial risks associated with a LIBOR financing. The disclosures must be made in a fair and balanced manner based on principles of fair dealing and good faith.
Municipal Advisors’ Duties
The MSRB reminds municipal advisors of their fiduciary duty owed to municipal entities and their duty of care owed to private-entity obligated persons in relation to LIBOR transactions. Under MSRB Rule G-42, on duties of non-solicitor municipal advisors, if a municipal advisor makes a recommendation of a municipal securities transaction or municipal financial product involving LIBOR to a municipal entity or obligated person client, it must have a reasonable basis to believe that the recommended municipal securities transaction or municipal financial product is suitable for the client, based on the information obtained through the reasonable diligence of the municipal advisor.[6]
Similarly, if the review of a recommendation of another party involving LIBOR is requested by the municipal entity or obligated person client and within the scope of the engagement, the municipal advisor must determine, based on the information obtained through the reasonable diligence of such municipal advisor, whether the municipal securities transaction or municipal financial product is or is not suitable for the client.[7]
In addition, the municipal advisor must inform the client of: (i) the municipal advisor’s evaluation of the material risks, potential benefits, structure, and other characteristics of the recommended municipal securities transaction or municipal financial product; (ii) the basis upon which the municipal advisor reasonably believes that the recommended municipal securities transaction or municipal financial product is, or (as may be applicable in the case of a review of a recommendation) is not, suitable for the client; and (iii) whether the municipal advisor has investigated or considered other reasonably feasible alternatives to the recommended municipal securities transaction or municipal financial product that might also or alternatively serve the client’s objectives.[8]
Additional Resources
The MSRB continues to monitor the potential market impact of the transition away from LIBOR and supports the educational initiatives of municipal market industry associations. Persons interested in learning more about the transition to LIBOR may want to access the MSRB resources on our Yield Curves and Benchmarks webpage.
[1] See Transition from LIBOR, ARRC, available at https://www.newyorkfed.org/arrc/sofr-transition (last accessed February 11, 2020). The ARRC’s recommended alternative is the Secured Overnight Financing Rate (i.e., SOFR).
[2] Both the SEC and FINRA have identified as an examination priority in fiscal year 2020 firms’ preparedness for and disclosures surrounding their readiness for the retirement of LIBOR at the end of 2021, particularly in relation to the effects of the transition on investors. See the SEC’s Office of Compliance Inspections and Examinations 2020 Examination Priorities and FINRA’s 2020 Risk Monitoring and Examination Priorities Letter.
[3] Id.
[4] Chairman Jay Clayton, Welcome Remarks to the Government Finance Officers Association (GFOA) Mini-Muni Conference (Nov. 14, 2019), available at https://www.sec.gov/news/speech/clayton-gfoa-conference-111419,
[5] See MSRB Notice 2012-25 (May 7, 2012) (the “2012 Interpretive Notice”); Exchange Act Release No. 66927 (May 4, 2012); 77 FR 27509 (May 10, 2012) (File No. SR-MSRB-2011-09); and MSRB Notice 2012-25 (May 7, 2012). See also MSRB Notice 2019-20 (Nov. 8, 2019); Exchange Act Release No. 87478 (Nov. 6, 2019); 84 FR 61660 (Nov. 13, 2019) (File No. SR-MSRB-2019-10) (the “2019 Amendments to the 2012 Interpretive Notice”). While the 2019 Amendments to the 2012 Interpretive Notice revised certain aspects of the 2012 Interpretive Notice, including by creating certain defined terms, the substantive principles associated with a dealer’s fair dealing obligation to deliver disclosures related to LIBOR transactions were not changed. Accordingly, this information is currently applicable and will remain applicable upon the November 30, 2020 compliance date for the 2019 Amendments to the 2012 Interpretive Notice. See MSRB Notice 2020-03 (Jan. 31, 2020) (announcing a November 30, 2020 compliance date for the 2019 Amendments to the 2012 Interpretive Notice) and MSRB Notice 2019-20 (“When a recommendation regarding a complex municipal securities financing has been made by an underwriter in a negotiated offering, the underwriter making the recommendation has an obligation under Rule G- 17 to communicate more particularized transaction-specific disclosures than those that may be required in the case of the recommendation of routine financing structures or products. The underwriter making the recommendation must also disclose the material financial characteristics of the complex municipal securities financing, as well as the material financial risks of the financing that are known to the underwriter and reasonably foreseeable at the time of the disclosure.”).
[6] Rule G-42(d). See also Rule G-42, Supplementary Material .09. (“A determination of whether a municipal securities transaction or municipal financial product is suitable must be based on numerous factors, as applicable to the particular type of client, including, but not limited to, the client’s financial situation and needs, objectives, tax status, risk tolerance, liquidity needs, experience with municipal securities transactions or municipal financial products generally or of the type and complexity being recommended, financial capacity to withstand changes in market conditions during the term of the municipal financial product or the period that municipal securities to be issued in the municipal securities transaction are reasonably expected to be outstanding and any other material information known by the municipal advisor about the client and the municipal securities transaction or municipal financial product, after reasonable inquiry.”).
[7] Rule G-42(d).
[8] Id.
