The Federal Reserve Board issued a proposal last week that would establish default rules for benchmark replacements in certain contracts that use as a reference rate the London Interbank Offered Rate (LIBOR), which will be discontinued in 2023. The proposal implements the Adjustable Interest Rate (LIBOR) Act, which was enacted in March 2022. Comments on the proposal must be filed no later than 30 days after the date the proposal is published in the Federal Register.
In response to the discontinuation of LIBOR, Congress enacted the LIBOR Act to provide a uniform, nationwide solution for replacing references to LIBOR in existing contracts with inadequate fallback provisions, meaning inadequate contract provisions for determining an alternative reference rate. For these contracts, the Board’s proposal would replace references to LIBOR in the contracts with the applicable Board-selected replacement rate after June 30, 2023. The proposal identifies separate Board-selected replacement reference rates for different types of contracts, including consumer credit transactions. As required by the LIBOR Act, each proposed replacement reference rate is based on the Secured Overnight Financing Rate (SOFR).
The CFPB has addressed the discontinuation of LIBOR through Regulation Z and Official Staff Commentary amendments issued in December 2021. The final rule became effective on April 1, 2022, with the exception of certain changes to two post-consummation disclosure forms that are effective on October 1, 2023. The mandatory compliance date for revisions to Regulation Z change-in-terms notice requirements is October 1, 2022 and the mandatory compliance date for all other provisions of the final rule was April 1, 2022.
Before the amendments, Regulation Z’s open-end 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 original index “becomes unavailable” or “is no longer available” and certain other conditions are met. Having determined 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 on or after April 1, 2021, including an index based on the SOFR.
For closed-end credit, Regulation Z provides that a refinancing subject to new disclosures results if a creditor adds a variable-rate feature to a closed-end credit product but that a variable-rate feature is not added when a creditor changes the index to one that is “comparable.” The final rule added new commentary that provides examples of the types of factors to be considered in determining whether a replacement index is a “comparable” index to a particular LIBOR-based index.
For consumer loans subject to Regulation Z that give the creditor or card issuer authority to replace a LIBOR-based index with a new index that is not based on LIBOR, the LIBOR Act would not require the creditor or card issuer to use a SOFR-based replacement index. However, pursuant to the LIBOR Act, the Fed-selected SOFR-based index will automatically replace a LIBOR-based index if the creditor or card issuer has not selected a replacement index by the earlier of the date LIBOR is discontinued or the latest date for selecting a replacement index under the terms of the credit contract.
The LIBOR Act provides a number of safe harbor provisions that protect a creditor that selects the SOFR-based rates designated in the Fed’s proposal as a replacement for a LIBOR-based index. For more recent closed-end adjustable-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-based index designated in the Fed’s proposal. Even if not required by the LIBOR Act, 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 LIBOR Act’s safe harbor provisions when selecting a replacement index. In addition, the safe harbor provisions should also be considered by noteholders or other creditors before selecting a replacement index for closed-end adjustable-rate mortgages or other closed-end variable-rate credit products that do not contractually require use of a SOFR-based replacement index.