The Federal Reserve Board made a proposallast week, which would establish default rules for benchmark replacements in certain contracts that use the London Interbank Offered Rate (LIBOR) as their benchmark rate, which will be discontinued in 2023. The proposal implements the Rate Act adjustable interest rate (LIBOR), which was enacted in March 2022. Comments on the proposal should be filed no later than 30 days after the date of publication of the proposal in the Federal Register.
In response to the LIBOR shutdown, Congress enacted the LIBOR Act to provide a uniform national solution to replace references to LIBOR in existing contracts with inadequate fallback provisions, meaning inadequate contractual provisions to determine a alternative reference rate. For these contracts, the Commission’s proposal would replace references to LIBOR in the contracts with the applicable replacement rate selected by the Commission after 30 June 2023. The proposal identifies separate replacement reference rates selected by the Commission for different types contracts, including consumer credit transactions. As required by LIBOR, each proposed alternative benchmark rate is based on the Secured Overnight Funding Rate (SOFR).
The CFPB addressed the removal of LIBOR through Regulation Z and Official Staff Commentary Amendments issued in December 2021. The final rule became effective April 1, 2022, except for certain changes to two post-consumer disclosure forms that became effective October 1, 2023. The mandatory compliance date for revisions to the change notification requirements of the terms of Rule Z is October 1, 2022 and the mandatory compliance date for all other provisions of the final rule was April 1, 2022.
Prior to the amendments, Regulation Z’s open-ended credit provisions only allowed HELOC creditors and card issuers to change an index and margin used to set the APR on a variable rate account when the index of origin “becomes unavailable” or “no longer available”. and certain other conditions are met. After determining that all parties would benefit if creditors and issuers could replace a LIBOR-based index before LIBOR becomes unavailable at the end of 2023, the final rule added a new provision that allows HELOC creditors and card issuers (subject to contractual limitations) to replace a LIBOR-based index with a replacement index and margin effective April 1, 2021, including a SOFR-based index.
For closed-end credit, Regulation Z provides that a refinance subject to new information is obtained if a creditor adds a floating-rate feature to a fixed-end credit product, but a floating-rate feature does not is not added when a creditor changes the index to one that is “comparable”. The final rule added a new commentary that provides examples of the types of factors to consider in determining whether a replacement index is a “comparable” index to a particular LIBOR-based index.
For Z-regulated consumer loans that allow the creditor or card issuer to replace a LIBOR-based index with a new index that is not LIBOR-based, LIBOR would not require creditor or card issuer to use an index based on SOFR. replacement index. However, in accordance with LIBOR, the SOFR-based index selected by the Fed will automatically replace a LIBOR-based index if the creditor or card issuer has not selected a replacement index at the earliest between the date on which LIBOR is discontinued or the latest date for selection of a replacement index under the terms of the credit agreement.
LIBOR provides a number of safe harbor provisions that protect a creditor who selects the SOFR-based rates designated in the Fed’s proposal as an alternative to a LIBOR-based index. For newer closed floating rate notes that use a LIBOR-based index, Fannie Mae and Freddie Mac adopted fallback language that would require the noteholder to replace a LIBOR-based index with the SOFR designated in the Fed proposal. Although not required by LIBOR, Regulation Z, or contract to replace a LIBOR-based index with a SOFR-based index, HELOC lenders and card issuers should consider whether to take advantage of the safe harbor provisions of LIBOR when selecting an index replacement. In addition, bondholders or other creditors should also consider the safe harbor provisions before selecting a replacement index for closed floating rate mortgages or other closed floating rate credit products. that do not contractually require the use of a SOFR. replacement index.