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FHA codifies SOFR for LIBOR-based ARMs
On March 1, FHA published a final rule in the Federal Register removing LIBOR as an approved index for adjustable-rate mortgages (ARMs) and replacing it with the Secured Overnight Financing Rate (SOFR) as the approved index for newly-originated forward ARMs. The final rule also codifies HUD’s removal of LIBOR and approval of SOFR as an index for newly-originated home equity conversion mortgages (HECM) ARMs, and establishes “a spread-adjusted SOFR index as the Secretary-approved replacement index to transition existing forward and HECM ARMs off LIBOR.” Additionally, the final rule makes several clarifying changes and establishes a 10 percentage points maximum lifetime adjustment cap for monthly adjustable rate HECMs. The agency considered comments received to its proposed rule published last October (covered by InfoBytes here), and said the updated policy will now “generally align with Fannie Mae, Freddie Mac, and Ginnie Mae's policies replacing LIBOR with the SOFR index.” The final rule is effective March 31.
U.S.-EU release statement on Joint Financial Regulatory Forum
On February 7-8, EU and U.S. participants, including officials from the Treasury Department, Federal Reserve Board, CFTC, FDIC, SEC, and OCC, participated in the U.S.-EU Joint Financial Regulatory Forum to continue their ongoing financial regulatory dialogue. According to a joint statement issued by the participants, the matters discussed focused on six themes: “(1) market developments and financial stability risks; (2) sustainable finance and climate-related financial risks; (3) regulatory developments in banking and insurance; (4) operational resilience and digital finance; (5) regulatory and supervisory cooperation in capital markets; and (6) anti-money laundering and countering the financing of terrorism (AML/CFT).”
The joint statement acknowledged that the Russia/Ukraine conflict, coupled with global economic uncertainty and inflationary pressures, have exposed “the financial system to downside risk both in the EU and in the U.S,” with participants stressing the importance of international coordination in monitoring vulnerabilities and building resilience against stability risks. During the forum, participants discussed recent developments related to sustainability-related financial disclosures, climate-related financial risks, cross-border bank resolution coordination, the transition away from LIBOR, digital finance operational resilience, and progress made in strengthening their respective AML/CFT frameworks.
Fannie, Freddie announce LIBOR transition plans
On December 22, GSEs Fannie Mae and Freddie Mac announced replacement indices based on the Secured Overnight Financing Rate (SOFR) for their legacy LIBOR indexed loans and securities (see here and here). The announcement follows the Federal Reserve Board’s final rule setting forth recommended replacement rates for financial contracts based on LIBOR (covered by InfoBytes here). For single-family mortgage loans and related mortgage-backed securities, the GSEs selected the relevant tenor of CME Term SOFR plus the applicable tenor spread adjustment, as published and provided by Refinitiv Limited (also known as “USD IBOR Cash Fallbacks” for “Consumer” products). The transition to the replacement indices will occur the day after June 30, 2023, which is the last date on which the Intercontinental Exchange, Inc. Benchmark Administration Limited will publish a representative rate for all remaining tenors of U.S. dollar LIBOR. The GSEs also published replacement indices for multifamily mortgage loans and related mortgage-backed securities, single family and multifamily collateralized mortgage obligations and credit risk transfer securities, and derivatives.
FSOC annual report highlights digital asset, cybersecurity, and climate risks
On December 16, the Financial Stability Oversight Council (FSOC or the Council) released its 2022 annual report. The report reviewed financial market developments, identified emerging risks, and offered recommendations to mitigate threats and enhance financial stability. The report noted that “amid heightened geopolitical and economic shocks and inflation, risks to the U.S. economy and financial stability have increased even as the financial system has exhibited resilience.” The report also noted that significant unaddressed vulnerabilities could potentially disrupt institutions’ ability to provide critical financial services, including payment clearings, liquidity provisions, and credit availability to support economic activity. FSOC identified 14 specific financial vulnerabilities and described mitigation measures. Highlights include:
- Nonbank financial intermediation. FSOC expressed support for initiatives taken by the SEC and other agencies to address investment fund risks. The Council encouraged banking agencies to continue monitoring banks’ exposure to nonbank financial institutions, including reviewing how banks manage their exposure to leverage in the nonbank financial sector.
- Digital assets. FSOC emphasized the importance of enforcing existing rules and regulations applicable to the crypto-asset ecosystem, but commented that there are gaps in the regulation of digital asset activities. The Council recommended that legislation be enacted to grant rulemaking authority to the federal banking agencies over crypto-assets that are not securities. The Council said that regulatory arbitrage needs to be addressed as crypto-asset entities offering services similar to those offered by traditional financial institutions do not have to comply with a consistent or comprehensive regulatory framework. FSOC further recommended that “Council members continue to build capacities related to data and the analysis, monitoring, supervision, and regulation of digital asset activities.”
- Climate-related financial risks. FSOC recommended that state and federal agencies should continue to work to advance appropriately tailored supervisory expectations for regulated entities’ climate-related financial risk management practices. The Council encouraged federal banking agencies “to continue to promote consistent, comparable, and decision-useful disclosures that allow investors and financial institutions to consider climate-related financial risks in their investment and lending decisions.”
- Treasury market resilience. FSOC recommended that member agencies review Treasury’s market structure and liquidity challenges, and continue to consider policies “for improving data quality and availability, bolstering the resilience of market intermediation, evaluating expanded central clearing, and enhancing trading venue transparency and oversight.”
- Cybersecurity. FSOC stated it supports partnerships between state and federal agencies and private firms to assess cyber vulnerabilities and improve cyber resilience. Acknowledging the significant strides made by member agencies this year to improve data collection for managing cyber risk, the Council encouraged agencies to continue gathering any additional information needed to monitor and assess cyber-related financial stability risks.
- LIBOR transition. FSOC recommended that firms should “take advantage of any existing contractual terms or opportunities for renegotiation to transition their remaining legacy LIBOR contracts before the publication of USD LIBOR ends.” The Council emphasized that derivatives and capital markets should continue transitioning to the Secured Overnight financing Rate.
CFPB Director Rohit Chopra issued a statement following the report’s release, flagging risks posed by the financial sector’s growing reliance on big tech cloud service providers. “Financial institutions are looking to move more data and core services to the cloud in coming years,” Chopra said. “The operational resilience of these large technology companies could soon have financial stability implications. A material disruption could one day freeze parts of the payments infrastructure or grind other critical services to a halt.” Chopra also commented that FSOC should determine next year whether to grant the agency regulatory authority over stablecoin activities under Dodd-Frank. He noted that “[t]hrough the stablecoin inquiry, it has become clear that nonbank peer-to-peer payments firms serving millions of American consumers could pose similar financial stability risks” as these “funds may not be protected by deposit insurance and the failure of such a firm could lead to millions of American consumers becoming unsecured creditors of the bankruptcy estate, similar to the experience with [a now recently collapsed crypto exchange].”
Fed issues final rule for LIBOR replacement
On December 16, the Federal Reserve Board adopted a final rule to implement the Adjustable Interest Rate Act by identifying benchmark rates based on the Secured Overnight Financing Rate (SOFR) that will replace LIBOR in certain financial contracts after June 30, 2023. The final rule ensures that LIBOR contracts adopting a benchmark rate selected by the Fed will not be interrupted or terminated following LIBOR’s replacement. Among other things, the final rule identifies: (i) SOFR-based Fed-selected benchmark replacements for LIBOR contracts that will not mature prior to the LIBOR replacement date and do not contain clear and practicable benchmark replacements; (ii) different SOFR-based Fed-selected benchmark replacements for different categories of LIBOR contracts, including overnight, one-month, three-month, six-month, and 12-month LIBOR contracts subject to the Act; and (iii) certain benchmark replacement conforming changes related to the implementation, administration, and calculation of the Fed-selected benchmark replacement. The Fed noted that in response to comments, the final rule restates safe harbor protections contained in the Act for selection or use of the replacement benchmark rate selected by the Fed, and clarifies who would be considered a “determining person” able to choose to use the replacement benchmark rate.
FHA seeks comment on LIBOR transition
On October 19, FHA published a proposed rule in the Federal Register seeking public comment on transitioning existing FHA-insured forward and home equity conversion mortgage (HECM) adjustable rate mortgages (ARMs) from LIBOR to a spread-adjusted Secured Overnight Financing Rate (SOFR) index, after the one-year and one-month LIBOR indices cease to be published on June 30, 2023. The proposed rule also mentioned removing LIBOR and adding SOFR as an approved index for newly originated forward ARMs. According to the proposed rule, this change was made for HECM ARMs in Mortgagee Letter 2021- 08 and added to this proposed rule. As previously covered by InfoBytes, in March 2021, FHA issued ML 2021-08 announcing changes for adjustable interest rate HECMs as the market transitions away from LIBOR. Comments are due by November 18.
CFTC updates its interest rate swap clearing requirements as LIBOR ends
On August 12, the CFTC issued a final rule updating its interest rate swap clearing requirement under part 50 of the CFTC’s regulations. Among other things, the final rule eliminates the requirement to clear interest rate swaps referencing LIBOR and other interbank offered rates and replaces them with requirements to clear interest rate swaps referencing overnight, nearly risk-free reference rates. The final rule also “updates the swaps required to be submitted for clearing to a derivatives clearing organization (DCO) or an exempt DCO and the compliance dates for such swaps.” According to CFTC Chairman Rostin Behnam, the final rule “promotes financial stability and mitigates systemic risk,” and “is essential to ensure cross border harmonization in the interest rate swaps market.” The final rule is effective 30 days after publication in the Federal Register.
U.S.-EU release statement on Joint Financial Regulatory Forum
On July 20, EU and U.S. participants, including officials from the Treasury Department, Federal Reserve Board, CFTC, FDIC, SEC, and OCC, participated in the U.S. – EU Joint Financial Regulatory Forum to continue their ongoing financial regulatory dialogue. Matters discussed focused on six themes: “(1) market developments and financial stability risks, (2) sustainable finance and climate-related financial risks, (3) regulatory developments in banking and insurance, (4) regulatory and supervisory cooperation in capital markets, (5) operational resilience and digital finance, and (6) anti-money laundering and countering the financing of terrorism (AML/CFT).”
The statement acknowledged that the Russia/Ukraine conflict, as well as “inflationary pressures”, exposes “a series of downside risks to financial markets both in the EU and in the U.S.” The statement notes that financial markets have so far proven to be “resilient” and stressed that “[i]nternational cooperation in monitoring and mitigating financial stability risks remains essential in the current global environment in light of the negative impacts on global energy and commodities markets.” During the Forum, participants also discussed recent developments related to digital finance and crypto-assets, including so-called stablecoins, as well as potential central bank digital currencies. Additionally, participants discussed various issues related to third-party providers; climate-related financial risks and challenges, including sustainability reporting standards; the transition away from LIBOR; and progress made in strengthening their respective AML/CFT frameworks.
Fed issues NPRM for default rules on certain LIBOR contracts
On July 19, the Federal Reserve Board announced in a notice of proposed rulemaking (NPRM) that it is soliciting comments on a proposal that provides default rules for certain contracts that use LIBOR, which would implement the Adjustable Interest Rate (LIBOR) Act. As previously covered by InfoBytes, LIBOR will be discontinued after June 30, 2023. The NPRM would establish benchmark replacements for the one-, three-, six-, and 12-month “tenors” of LIBOR where a given contract does not have terms that provide for the use of any substitute for the specified LIBOR rate. According to the NPRM, “[o]f particular concern are so-called ‘tough legacy contracts,’ which are contracts that reference USD LIBOR and will not mature by June 30, 2023, but which lack adequate fallback provisions providing for a clearly defined or practicable replacement benchmark following the cessation of USD LIBOR.” The proposal identifies separate Fed-selected replacement rates for derivatives transactions, contracts where a government-sponsored enterprise is a party, and all other affected contracts. As required by the law, each proposed replacement rate is based on the Secured Overnight Financing Rate. Comments on the proposal are due 30 days after publication in the Federal Register.
Find continuing InfoBytes coverage on LIBOR here.
ARRC recommends transition steps for legacy USD LIBOR cash product contracts
On July 11, the Alternative Reference Rates Committee (ARRC) released the LIBOR Legacy Playbook to help support the transition away from legacy LIBOR cash products. ARRC estimated that approximately $74 trillion in legacy USD LIBOR exposures will mature after June 30, 2023, when the remaining USD LIBOR panels will cease. Of this amount, roughly $5 trillion are in cash products, which do not carry the benefit of a protocol process that will allow market participants to adopt a uniform set of robust fallbacks or a simple mechanism to determine which contracts are covered by those fallbacks. Rather, cash products have a range of fallbacks, the ARRC said, explaining that “currently there is no simple way, other than in many cases manual effort, to determine what the fallback for each contract is. Careful work will be needed to communicate the associated rate changes to counterparties to these contracts.”
The Playbook includes a compilation of publications by the ARRC and other available reference material to assist market participants in ensuring that the transition from LIBOR is operationally successful. The Playbook also recommends steps for market participants to take to successfully implement fallbacks for cash products, including: (i) thoroughly assessing the fallbacks that are embedded (either contractually or through legislation) in every USD LIBOR contract; (ii) remediating these contracts where feasible to reference the Secured Overnight Financing Rate prior to June 30, 2023; and (iii) adopting plans to communicate each contract’s fallback with affected parties for remaining LIBOR contracts, and making sure sufficient resources are allocated to ensure that rate changes are successfully implemented. The ARRC stressed that its recommendations are voluntary and that market participants must make independent decisions about how best to transition existing contracts to an alternative rate upon the cessation of USD LIBOR.
Find continuing LIBOR InfoBytes coverage here.
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Upcoming Events
- Keisha Whitehall Wolfe to discuss “Tips for successfully engaging your state regulator” at the MBA's State and Local Workshop
- Max Bonici to discuss “Enforcement risk and trends for crypto and digital assets (Part 2)” at ABA’s 2023 Business Law Section Hybrid Spring Meeting
- Jedd R. Bellman to present “An insider’s look at handling regulatory investigations” at the Maryland State Bar Association Legal Summit