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Proposed federal LIBOR transition regulations
Author:
Global | Publikation | Juli 2022
On Tuesday, July 19, 2022, the Federal Reserve Board (the Board) solicited public comment on its proposed LIBOR transition regulations, made pursuant to the Adjustable Interest Rate (LIBOR) Act (the LIBOR Act), which was signed into law on March 15, 2022. The LIBOR Act specified that, by operation of law, a Secured Overnight Financing Rate (SOFR)-based benchmark would replace LIBOR in "tough legacy" contracts. A "tough legacy contract" is a LIBOR contract that will not mature before LIBOR ceases to be published or becomes nonrepresentative (June 30, 2023) and does not contain adequate LIBOR-fallback language.1 The LIBOR Act directed the Board to promulgate regulations to carry out the LIBOR Act's mandate within 180 days of the bill's enactment.
Regulation ZZ limits the applicability of the proposed regulations to "covered contracts." Covered contracts are LIBOR contracts that either contain: (i) no fallback provisions, (ii) inadequate fallback provisions (i.e. the fallback provisions do not specify a LIBOR replacement or select a determining person2) or (iii) a fallback provision that identifies a determining person, but the determining person fails to identify a replacement benchmark before LIBOR goes offline or becomes nonrepresentative.3 The proposed regulations also state that a "covered contract" is not a contract in which the parties have agreed that their contract will not be subject to the LIBOR Act.
Regulation ZZ would select different Board-selected replacement (i.e. SOFR-based) benchmarks for different financial instruments. For derivatives, the Board's proposed regulations would adopt the ISDA protocol and replace LIBOR with SOFR compounded in arrears for the applicable tenor, plus the applicable credit adjustment spread specified in the LIBOR Act.
For cash transactions that are non-consumer loans or covered government-sponsored enterprise (GSE) contracts, the Board's proposed regulations would replace existing one-, three-, six- and 12-month LIBOR with one-, three-, six- or 12-month CME Term SOFR plus the applicable credit adjustment spread specified in the LIBOR Act.4
For cash transactions that involve consumer loans, the Board likewise proposed a shift from LIBOR to the corresponding overnight-, one-, three-, six- or 12-month CME Term SOFR tenor. However, pursuant to Section 104(e)(2) of the LIBOR Act, Regulation ZZ would initially transition from overnight, one-, three-, six- or 12-month LIBOR to the corresponding SOFR (in the case of overnight tenors) or CME Term SOFR (in the case of one-, three-, six- or 12-month tenors) tenor "linearly for each business day during that period" from (1) the difference between SOFR (or Term SOFR, as applicable) and the corresponding LIBOR tenor determined as of the day immediately before the LIBOR Replacement Date (June 30, 2023) to (2) the applicable credit adjustment spreads specified in the LIBOR Act.5 In other words, for cash transactions involving consumer loans, after the initial transition from LIBOR to SOFR, the implementation of the applicable credit adjustment spread would occur gradually.6 For GSE contracts, the proposed rule would select 30-day compounded average SOFR plus the applicable credit adjustment spread as the applicable LIBOR replacement.
Notably, the Board declined at this time to propose any regulations pertaining to implementing any benchmark replacement conforming changes. The Board's proposed rules would take effect 30 days after the publication of the final rules in the Federal Registrar.
View a copy of the proposed regulations and request for comment.
Footnotes
1
Section 104 of the LIBOR Act defined "fallback provisions" broadly to include terms in a contract for establishing a benchmark replacement for LIBOR.
2
A determining person is one who is permitted, under the terms of the contract, to select a benchmark replacement.
3
There has been speculation that LIBOR could continue to be published after the specified end date of June 30, 2023, at which point LIBOR will not be based on any underlying market activity (and become "Synthetic LIBOR") that is "nonrepresentative." In its proposal, the Board discussed the possibility that some fallback provisions may not be clearly triggered if Synthetic LIBOR emerges. And the Board contemplated making explicit in its final regulations that the emergence of Synthetic LIBOR would not serve to delay the triggering of such fallback language.
4
In May, the Alternative Reference Rates Committee (ARRC) formally recommended CME Term SOFR, administered by the CME Group Benchmark Administration Limited.
5
0.00644 percent for overnight LIBOR; 0.11448 percent for one-month LIBOR; 0.26161 percent for three-month LIBOR; 0.42826 percent for six-month LIBOR and 0.71513 percent for 12-month LIBOR. Refinitiv Limited has indicated it will publish a rate consistent with the proposed rule, and the proposed regulations specify that the rates published by Refinitiv Limited would be deemed equivalent to the rates mandated by the proposed rule.
6
The gradual tenor spread adjustment shift was included to prevent consumers from experiencing sudden shifts in borrowing rates as a result of the transition from LIBOR to SOFR.
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