Federal Reserve Board Adopts Final Version of LIBOR Transition RuleRead Time: 2 mins
As previously noted in our August 30, 2022 alert, the Board of Governors of the Federal Reserve System (the FRB) published a proposed regulation to implement the Adjustable Rate (LIBOR) Act (the Act). As explained in the earlier alert, the purpose of the Act was to facilitate the transition away from the use of LIBOR as an index for variable rate loans due to LIBOR’s scheduled sunset on June 30, 2023. The final regulation, Regulation ZZ, was released on December 16, 2022. While Regulation ZZ will technically become effective 30 days after its publication in the Federal Register, in practice, Regulation ZZ will take effect in the period around June 30, 2023, as LIBOR sunsets.
Regulation ZZ is substantially similar to the FRB’s proposed regulation. As such, Regulation ZZ largely follows the text of the Act by providing a mechanism that will, by operation of law, replace contractual references to LIBOR with the benchmark replacements described in Regulation ZZ. For consumer loans, which are the focus of this alert, the benchmark replacements will be the CME Term SOFR, which is based on the Secured Overnight Financing Rate (SOFR), a rate published daily by the Federal Reserve Bank of New York. During a one-year transition period beginning on June 30, 2023, tenor spread adjustments will be added to the CME Term SOFR to minimize adverse effects on consumer borrowers. These adjustments are provided in Regulation ZZ.
The Supplemental Information to Regulation ZZ clarifies that it will apply to “tough legacy contracts” that allow the lender or other determining person identified in the contract to select a benchmark replacement when LIBOR is unavailable. Whether the Act was limited to situations where LIBOR was available but no longer reliable was an issue noted by the FRB when it published its proposed rule. After reviewing the comments it received and considering the issue further, the FRB now believes that it has the authority under the Act to apply the transition mechanism of Regulation ZZ to all contracts that use LIBOR as the benchmark rate, which is a result that the lending industry will welcome. Note, however, the requirements of Regulation ZZ generally do not apply to LIBOR contracts with an effective fallback provision, such as those with a defined and practicable benchmark for LIBOR, or with a “determining person” who has the authority, right, or obligation to determine a benchmark replacement.
It should also be noted that Regulation ZZ implements the safe harbor provisions of the Act so that lenders following the provisions of Regulation ZZ will not be subject to any liability for transitioning from LIBOR to SOFR.
Finally, while the FRB reiterated in the Supplemental Information to Regulation ZZ that it does not impose any notice requirements in connection with consumer loans, the FRB noted that a lender should select SOFR prior to June 30 to accommodate rate reset contractual provisions that would occur after that date so that LIBOR could continue to be used until the first reset date after June 30. We anticipate that most consumer lenders will send communications to their borrowers in the period before June 30, 2023, to explain the upcoming transition from LIBOR to SOFR and will include an explicit “selection” of SOFR in those communications to provide for a seamless transition between benchmark rates.