ARRC Publishes LIBOR Transition Aid Tool for Internal Systems and Processes

The Alternative Reference Rates Committee (ARRC) recently released a taxonomy tool that firms can use to help structure their transition from LIBOR to the Secured Overnight Financing Rate (SOFR).  Firms may find this document, entitled “Internal Systems & Processes: Transition Aid for SOFR,” to be an important aid in planning the steps needed to make a smooth transition to SOFR when the LIBOR likely becomes unusable after 2021.  It fills in many of the details that have been outlined in earlier ARRC publications, including the User’s Guide to SOFR and the Practical Implementation Checklist and Buy-Side Checklist.

In general, the taxonomy tool broadly classifies transition activities into the following ten categories: (i) product and business development; (ii) trading and brokerage; (iii) client servicing; (iv) trading risk management; (v) data management; (vi) operations; (vii) risk controls; (viii) financial controls; (ix) legal and compliance; and (x) information technology.  The categories are further broken down into 50 selected sub-categories (e.g., category: 3. client servicing; sub-category: 3.1 lending). 

The tool also provides a one-page summary for each of the sub-categories, which lists certain transition steps and activities for market participants to consider, as well as sections discussing impacted systems and processes that may be affected by transition.  The summaries also identify additional transitional considerations and dependencies that may influence the timing and sequence of transition activities.

For example, with respect to “category: 3. client servicing; sub-category 3.1 lending,” the taxonomy tool indicates that the systems impacted by the LIBOR transition are the servicing system, the origination system, and the secondary marketing model/database.  The tool also lists certain transition steps and activities a firm should take to prepare for the transition regarding servicing/lending, including:

• Conducting training sessions for relevant personnel on the concept of index rate changes and how they will impact borrowers’ payments so they can articulate the changes effectively to borrowers.
• Strategizing and designing effective ways to notify borrowers before the index rate changes take effect.
• Establishing a robust contract amendment process based on state and regulatory guidelines.

In addition, the taxonomy tool states that a seamless transition between mortgage servicing rights (MSR) transfers is required in order to avoid disruptions in principal and interest advances because volatility on the interest rate will affect the value of the MSRs.