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CFPB finalizes LIBOR transition rule
On December 7, the CFPB issued a final rule facilitating the transition from LIBOR for consumer financial products. (Corrected rule published February 16, 2022.) The final rule amends Regulation Z, which implements TILA, to generally address LIBOR’s eventual cessation for most U.S. dollar settings in June 2023, and establishes requirements for how creditors must select replacement indices for existing LIBOR-linked consumer loans.
- Closed-end provision amendments provide examples of indices that meet certain Regulation Z standards, which may be used to replace LIBOR indices. To assist creditors in determining a comparable index for closed-end loans, the final rule identifies certain Secured Overnight Financing Rate (SOFR)-based spread-adjusted indices recommended by the Alternative Reference Rates Committee (ARRC) for consumer products. The final rule also provides a non-exhaustive list of factors for creditors to use when determining whether a replacement index meets the Regulation Z “comparable” standard.
- Updated post-consummation disclosure sample forms for certain adjustable-rate mortgage loan products replace LIBOR references with a SOFR index.
- Amendments related to open-end loans add LIBOR-specific provisions, which allow creditors for home equity lines of credit (HELOCs) and credit card issuers to transition existing accounts using a LIBOR index to a replacement index on or after April 1, 2022, provided certain conditions are met. Creditors and card issuers are provided a non-exhaustive list of factors to consider when determining whether a replacement index meets Regulation Z’s “historical fluctuations are substantially similar” standard. In addition to identifying certain ARRC recommended SOFR-based spread-adjusted indices for consumer products, the final rule also lists the Prime rate as an example of an index that also meets this standard.
- The final rule also addresses change-in-terms notice provisions for HELOCs and credit card accounts related to the disclosure of margin reductions once LIBOR ends. Additionally, the final rule discusses how the requirement for reevaluating rate increases on credit card accounts applies to the transition from using LIBOR indices to a replacement index.
The final rule takes effect April 1, 2022, with the exception of certain provisions related to an amendment to appendix H which is effective October 1, 2023. Additionally, while the mandatory compliance date for change-in-terms notice requirement revisions is October 1, 2022, the mandatory compliance date for all other final rule provisions is April 1, 2022. Furthermore, the Bureau “is reserving judgment about whether to include references to a 1-year USD LIBOR index and its replacement index in various comments; the Bureau will consider whether to finalize comments proposed on that issue in a supplemental final rule once it obtains additional information.”
CFPB Director Rohit Chopra warned that “[n]o new financial contracts may reference LIBOR as the relevant index after the end of 2021,” and that beginning June 2023, “LIBOR can no longer be used for existing financial contracts.” Chopra further emphasized that creditors and servicers must continue to prepare for LIBOR’s cessation and should take clear and orderly steps to reduce risk and mitigate compliance, legal, financial, and operational risks.
ARRC recommends SOFR fallbacks for one-week, two-month LIBOR contracts
On December 3, the Alternative Reference Rates Committee (ARRC) under the New York and Alabama LIBOR Relevant Recommending Body, released a statement recommending forms of the Secured Overnight Financing Rate (SOFR) and associated spread adjustments to replace references to 1-week and 2-month USD LIBOR in certain contracts affected by New York and Alabama state LIBOR legislation. The statement comes “with just one month until no new LIBOR and the cessation of these two USD LIBOR tenors,” noting that these recommendations are “important for the legacy contracts that rely on those tenors.” Under the states’ LIBOR legislation, ARRC serves as the “Relevant Recommending Body,” while SOFR is the recommended rate and alternative to USD LIBOR.
As previously covered by InfoBytes, ARRC announced its recommendation of CME Group’s forward-looking SOFR term rates, following the completion of key changes in trading conventions on July 26 under the SOFR First initiative. According to the recently released statement, ARRC recommends applying SOFR only to the narrow set of LIBOR-based contracts that are affected by the states’ LIBOR legislation, which are generally contracts with no fallbacks or fallbacks that reference LIBOR. For contracts with fallbacks that give a party discretion to decide on a replacement rate, the state laws also provide a safe harbor if that party chooses the SOFR-based rate and conforming changes recommended by ARRC. ARRC also published a set of frequently asked questions regarding the application of New York state law.
OCC to focus supervisory efforts on non-SOFR rates after LIBOR ends
On October 26, acting Comptroller of the Currency Michael J. Hsu warned banks not to be complacent when transitioning away from LIBOR. Hsu reiterated that federal regulators will not allow new contracts that use LIBOR as a reference rate after December 31. Hsu stressed that banks must look outside of activities that directly involve LIBOR exposure, such as lending, derivatives activities, and market-making capacities, to screen for LIBOR exposure in other contexts, such as LIBOR-based loan participation interests or as part of an instrument for a bank’s investment or liquidity portfolio paying LIBOR-based income or otherwise reflecting LIBOR exposures. As previously covered by InfoBytes, the CFPB, Federal Reserve Board, FDIC, NCUA, and OCC recently released a joint statement providing supervisory considerations for institutions when choosing an alternative reference rate. Hsu addressed the use of these alternative reference rates and reminded banks that they are expected to be able to demonstrate that their replacement rate is robust and appropriately tailored to their risk profile. He further commented that because the Secured Overnight Financing Rate (SOFR) “provides a robust rate suitable for use in most products, with underlying transaction volumes that are unmatched by other alternatives,” the OCC will initially focus its supervisory efforts on non-SOFR rates.
ARRC recommends firms reduce use of LIBOR before year end
On October 14, the Alternative Reference Rates Committee (ARRC) recommended that all market participants take proactive action now to reduce their use of U.S. dollar LIBOR to promote a smooth end to new LIBOR contracts by year end. ARRC referred to a joint statement issued last November by the Federal Reserve Board, FDIC, and OCC encouraging banks to cease entering into new contracts that use LIBOR as a reference rate as soon as practicable, but by December 31, 2021 at the latest. (Covered by InfoBytes here.) According to the agencies, entering into contracts after this date will create safety and soundness risks given consumer protection, litigation, and reputation risks at stake. ARRC recommended that firms adopt its selected alternative, the Secured Overnight Financing Rate, which is consistent with steps that several firms have already taken to ensure they are in the position to meet the supervisory guidance. This includes “setting targets for reductions in new LIBOR activity, limiting the range of LIBOR offerings, and implementing internal escalation exceptions processes around new LIBOR contracts for narrow cases in line with supervisory guidance.”
HUD and Fed consider transition from LIBOR
On October 5, HUD issued an advanced notice of proposed rulemaking (ANPRM) seeking comments regarding the transition from the London Interbank Offered Rate (LIBOR) to alternate indices on adjustable rate mortgages (ARMs). According to the ANPRM, most ARMs insured by FHA are based on LIBOR, which is likely to become uncertain after December 31 and to no longer be published after June 30, 2023. Due to the uncertainty, HUD has begun to transition away from LIBOR and has approved the Secured Overnight Financing Rate (SOFR) index in some circumstances. In recognizing that there may be certain difficulties for mortgagees transitioning to a new index, HUD “is considering a rule that would address a Secretary-approved replacement index for existing loans and provide for a transition date consistent with the cessation of the LIBOR index.” Furthermore, HUD “is also considering replacing the LIBOR index with the SOFR interest rate index, with a compatible spread adjustment to minimize the impact of the replacement index for legacy ARMs.” Comments on the ANPRM are due by December 6.
The same day, Federal Reserve Vice Chair for Supervision Randal K. Quarles spoke at the Structured Finance Association Conference in Las Vegas, Nevada, reminding participants that they should cease utilizing LIBOR by the end of the year, “no matter how unhappy they may be with their options to replace it,” and further warned that the Fed will supervise firms accordingly. Quarles emphasized that, “[g]iven the availability of SOFR, including term SOFR, there will be no reason for a bank to use [LIBOR] after 2021 while trying to find a rate it likes better.”
SEC’s Gensler supports SOFR
On September 20, SEC Chair Gary Gensler issued remarks before the Alternative Reference Rates Committee (ARRC) regarding the transition from the London Interbank Offered Rate (LIBOR) to a “preferable” Secured Overnight Financing Rate (SOFR). Gensler expressed his concerns for the Bloomberg Short-Term Bank Yield Index (BSBY), citing that BSBY's flaws are similar to those of LIBOR, including that “[b]oth benchmarks are based upon unsecured, term, bank-to-bank lending.” He also pointed out that the BSBY term is “underpinned primarily by trades of commercial paper and certificates of deposit issued by 34 banks,” and “the median trading volume behind three-month BSBY is less than $10 billion per day.” In expressing his support for SOFR, Gensler stated that SOFR is based on an approximate trillion-dollar market.
ARRC announces recommendation for SOFR term rate
On July 29, the Alternative Reference Rates Committee (ARRC) announced its recommendation of CME Group’s forward-looking Secured Overnight Financing Rate (SOFR) term rates, following the completion of key changes in trading conventions on July 26 under the SOFR First initiative. As previously covered by InfoBytes, ARRC announced in March that it “will not be in a position to recommend a forward-looking [SOFR term rate] by mid-2021.” However, the success of the SOFR First convention change, “along with the continued growth in SOFR cash and derivatives markets, has allowed the ARRC to recommend SOFR Term Rates, consistent with the principles and indicators it established to do so.” Federal Reserve Board Vice Chair for Supervision Randal K. Quarles noted that “[a]ll firms should be moving quickly to meet our supervisory guidance advising them to end new use of LIBOR this year.”
In addition to the announcement, ARRC released a factsheet outlining past milestones, SOFR’s strengths, and anticipated milestones. ARRC noted that SOFR is “the best replacement” for USD LIBOR because it is (i) deep enough to “not dry up in times of market stress”; (ii) resilient against market evolution; and (iii) entirely transaction-based, and therefore cannot be easily manipulated.
Agencies call for "robust" alternate reference rates
On June 11, the Treasury Department, OCC, SEC, and the FDIC released separate statements following the meeting of the Financial Stability Oversight Council concerning the LIBOR transition. Acting Comptroller of the Currency Michael Hsu said it is “imperative that banks continue careful planning” for the transition away from LIBOR to an alternate reference rate, such as the Secured Overnight Financing Rate (SOFR), the Alternate Reference Rates Committee’s (ARRC) preferred LIBOR alternative. As previously covered by InfoBytes, the ARRC released the SOFR “Starter Kit” in August 2020, which includes three factsheets that are the result of a series of educational panel discussions held by ARRC. The various panel discussions were designed to educate on “the history of LIBOR; the development and strengths of SOFR; progress made in the transition away from LIBOR to date; and how to ensure organizations are ready for the end of LIBOR.” SEC Chairman Gary Gensler also expressed support for SOFR, calling it a “preferable” alternate rate. In addition, Gensler shared his concerns regarding the Bloomberg Short-Term Bank Yield Index (BSBY), which some commercial banks are advocating as a replacement for LIBOR. Gensler said the BSBY is based upon unsecured, term, bank-to-bank lending, which is like LIBOR. Treasury Secretary Janet Yellen encouraged market participants to “act promptly to support the switch in derivatives from LIBOR to SOFR.” She noted that “[w]hile important progress is being made in some segments of the market, other segments, including business loans, are well behind where they should be at this stage in the transition.” FDIC Chairman Jelena McWilliams pointed out that the “FDIC continues to focus on the LIBOR transition and to assess institutions’ practices and plans to adopt a replacement rate and address legacy contracts before December 31 of this year.” However, she disclosed that “the FDIC does not endorse any particular alternative reference rate.”
New York enacts LIBOR replacement provisions
On April 6, the New York Governor signed S297B into law, which addresses the permanent discontinuance of LIBOR for specified contracts, securities, and other instruments that are economically tied to LIBOR. Among other things, S297B stipulates that contracts using LIBOR as a benchmark that do not contain adequate interest rate fallback provisions (or contain a fallback provision “that result[s] in a benchmark replacement, other than a recommended benchmark replacement, that is based in any way on any LIBOR value”) will automatically convert to the “recommended benchmark replacement”—currently the secured overnight financing rate (SOFR)—when LIBOR is no longer available. As previously covered by InfoBytes, all sterling, euro, Swiss franc and Japanese yen settings, and one-week and two-month U.S. dollar settings will cease immediately after December 31, 2021, while all remaining U.S. dollar settings will cease immediately after June 30, 2023. Of note, S297B will not override LIBOR replacements that are mutually agreed upon by contracting parties, and provides a safe harbor from liability for parties that use a recommended benchmark replacement. Further, parties are also prohibited from discharging or refusing to perform contractual obligations or declaring a breach of contract as a result of the discontinuance of LIBOR or the use of a replacement.
Find continuing InfoBytes coverage on LIBOR here.
ARRC not yet in a position to recommend forward-looking SOFR term rate
On March 23, the Alternative Reference Rates Committee (ARRC) announced that it “will not be in a position to recommend a forward-looking Secured Overnight Financing Rate (SOFR) term rate by mid-2021.” Additionally, ARRC noted that it cannot guarantee that it will be able to recommend an administrator to produce a robust forward-looking term rate by the end of 2021, when certain LIBOR U.S. dollar settings cease being published (covered by InfoBytes here). ARRC “encourage[d] market participants to continue to transition from LIBOR using the tools available now,” such as the SOFR averages and index data and ARRC’s A User’s Guide to SOFR, and “not to wait for a forward-looking term rate for new contracts.”
Federal Reserve Board Vice Chair for Supervision Randal K. Quarles also discussed “safety and soundness risks associated with the continued use of USD LIBOR in new transactions after 2021.” Speaking at “The SOFR Symposium: The Final Year” hosted by ARRC, Quarles expressed concerns that use of USD LIBOR has actually increased over the past three years, and emphasized that there should be no “remaining doubts as to exactly when and whether LIBOR will end.” Among other things, Quarles also highlighted a recent Fed supervisory letter (covered by InfoBytes here), which provides supervisory guidance for examiners to consider when assessing an institution’s plan to transition away from LIBOR.
Find continuing InfoBytes coverage on LIBOR here.