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On May 2, FHA published Mortgagee Letter (ML) 2023-09 to implement provisions of the Adjustable Rate Mortgages (ARM): Transitioning from LIBOR to Alternative Indices final rule that was published in the Federal Register at the beginning of March. (Covered by InfoBytes here.) The final rule replaces LIBOR with the Secured Overnight Financing Rate (SOFR) as the approved index for newly-originated forward ARMs, codifies HUD’s 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.” The ML provides interest rate transition directions for mortgagees and announces the availability of updated HECM model loan documents, which have been revised to be consistent with the final rule and the ML. The provisions in the ML have various effective dates.
On April 26, the CFPB joined the Federal Reserve Board, FDIC, NCUA, and OCC in issuing a joint statement on the completion of the LIBOR transition. (See also FDIC FIL-20-2023 and OCC Bulletin 2023-13.) According to the statement, the use of USD LIBOR panels will end on June 30. The agencies reiterated their expectations that financial institutions with USD LIBOR exposure must “complete their transition of remaining LIBOR contracts as soon as practicable.” Failure to adequately prepare for LIBOR’s discontinuance may undermine financial stability and institutions’ safety and soundness and could create litigation, operational, and consumer protection risks, the agencies stressed, emphasizing that institutions are expected to take all necessary steps to ensure an orderly transition. Examiners will monitor banks’ efforts throughout 2023 to ensure contracts have been transitioned away from LIBOR in a manner that complies with applicable legal requirements. The agencies also reminded institutions that safe-and-sound practices include conducting appropriate due diligence to ensure that replacement alternative rate selections are appropriate for an institution’s products, risk profile, risk management capabilities, customer and funding needs, and operational capabilities. Institutions should also “understand how their chosen reference rate is constructed and be aware of any fragilities associated with that rate and the markets that underlie it,” the agencies advised. Both banks and nonbanks should continue efforts to adequately prepare for LIBOR’s sunset, the Bureau said in its announcement, noting that the agency will continue to help institutions transition affected consumers in an orderly manner.
The Bureau also issued an interim final rule on April 28 amending Regulation Z, which implements TILA, to update various provisions related to the LIBOR transition. The interim final rule updates the Bureau’s 2021 LIBOR Transition Rule (covered by InfoBytes here) to reflect the enactment of the Adjustable Interest Rate Act of 2021 and its implementing regulation promulgated by the Federal Reserve Board (covered by InfoBytes here). Among other things, the interim final rule further addresses LIBOR’s sunset on June 30, by incorporating references to the SOFR-based replacement—the Fed-selected benchmark replacement for the 12-month LIBOR index—into Regulation Z. The interim final rule also (i) makes conforming changes to terminology used to identify LIBOR replacement indices; and (ii) provides an example of a 12-month LIBOR tenor replacement index that meets certain standards within Regulation Z. The Bureau also released a Fast Facts summary of the interim final rule and updated the LIBOR Transition FAQs.
The interim final rule is effective May 15. Comments are due 30 days after publication in the Federal Register.
On April 21, the Alternative Reference Rates Committee (ARRC) announced the endorsement of the CME Group’s Term SOFR rates, which ARRC formally recommended in 2021 (covered by InfoBytes here). The ARRC endorsement recommended that use of Term SOFR rates be limited to specific purposes, including as a fallback rate for legacy LIBOR cash products, for new use in business loans and certain securitizations, and for use in derivatives issued to end-users to hedge cash products that reference the Term SOFR rate. ARRC stated that, while it recognizes the usefulness of Term SOFR in certain business lending transactions, it continues to recommend the use of overnight SOFR and SOFR averages for all products. ARRC further encouraged market participants “to continue to monitor use of Term SOFR over time given the importance that such use continues to be proportionate to the base of transactions underlying the Term SOFR rate, and does not materially detract from those transactions in a way that compromises the robustness of the Term SOFR rate itself as the market evolves, as outlined in the ARRC’s principles.” Additionally, ARRC stated that the recommended uses outlined within the document regarding the use of Term SOFR will not change and “are meant to apply as permanent recommendations for the market.”
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.
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.
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].”
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.
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.
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.
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.