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Globally, the London Interbank Offered Rate (LIBOR) is one of the most widely used interest rate benchmarks. However, the one-week and two-month LIBOR will no longer be published after December 31, 2021 and the one-day, one-month, six-month, and one-year LIBOR will no longer be published on June 30, 2023, necessitating a transition away from LIBOR. This article briefly discusses the reasons why LIBOR is expected to end and then concentrates on how financial institutions should prepare for this eventuality.
The End of LIBOR
LIBOR is calculated as the average of interest rates that a panel of large London banks report that they would charge other banks to borrow unsecured for a specified period of time. Despite LIBOR’s widespread use as a reference rate by financial institutions, its reliability and sustainability have been called into question in recent years for a number of different reasons.
Concerned that LIBOR was becoming less stable and reliable, the Financial Conduct Authority (FCA), the United Kingdom’s financial regulator, announced in May 2017 that by the end of 2021, it would no longer compel banks to report their interest rates to the LIBOR administrator. The FCA also explained that although it would no longer require banks to submit their rates to the administrator, it would not prohibit banks from continuing to submit their LIBOR data after 2021. LIBOR’s administrator had previously stated that it will continue to calculate LIBOR as long as at least five banks continue to submit their information. This brought fears that LIBOR would continue to exist after the cessation of LIBOR but the rate would no longer be representative of the inter-bank interest rate offered and accepted by major financial institutions. There were also fears that this number would be more volatile. This occurrence has been referred to as the “zombie LIBOR.”
In an update on the timeline on the cessation of LIBOR, on March 5, 2021, the FCA and ICE Benchmark Administration announced that the one-week and two-month LIBOR will cease being published on December 31, 2021. The remaining tenors will cease to be published on a representative basis on June 30, 2023. With this, LIBOR’s administrator announced that a large number of its panel banks communicated that they would not be willing to continue contributing to the LIBOR tenors after these dates. Therefore, LIBOR’s administrator announced that as a result, it would stop publishing the relevant LIBOR rates on the announced dates unless the FCA exercised powers to require it to publish LIBOR on a synthetic basis. The FCA has stated that in circumstances where the synthetic rate may be compelled, it would not be representative of underlying markets.
In November 2020, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency (“OCC”), and the Federal Deposit Insurance Corporation (“FDIC”) issued a joint statement encouraging banks to stop using LIBOR as a reference rate in any new contracts as soon as practicable, and in any event by December 31, 2021. The statement emphasized that LIBOR’s continued use after this date would create safety and soundness risks that examiners would be instructed to examine accordingly. Further, the joint statement stressed that new contracts entered into before December 31, 2021 should either utilize a reference rate other than LIBOR or include robust fallback language identifying a replacement rate.
The FCA’s announcements have made the future of LIBOR uncertain but clarified the increasing risk associated with continued reliance on LIBOR. With these announcements, it is clear that financial institutions must prepare for the end of LIBOR.
Transition from LIBOR to SOFR
Based on the potential problems with LIBOR in 2021, market participants and regulators have worked to identify the best alternative reference rate to replace LIBOR and implement plans to transition to that reference rate. The Federal Reserve convened the Alternative Reference Rates Committee (ARRC) to identify a more robust reference rate and to facilitate the transition way from LIBOR. The ARRC is composed of many private-sector entities that have a presence in markets that are impacted by LIBOR. Further, several federal regulators, including the FDIC, the Federal Reserve, the OCC, and the CFPB, serve as non-voting, ex officio members of the ARRC.
In 2017, the ARRC identified the Secured Overnight Financing Rate (SOFR) as its recommended best alternative to LIBOR. SOFR is based on transactions in the U.S. Treasury repurchase market, measuring the cost of borrowing cash overnight collateralized U.S. Treasury securities in the market. Because of the size and liquidity of the market underlying SOFR, the ARRC believes that the index is more robust and resilient than LIBOR. To support the transition to SOFR, the ARRC has begun implementing steps to help SOFR gain momentum. As a part of this work, in April 2018, the New York Federal Reserve Board began publishing SOFR in conjunction with the Office of Financial Research.
Following the selection of SOFR as its alternative reference rate, the ARRC also published a Paced Transition Plan that outlines specific steps and timelines to promote the adoption of SOFR. These steps focus on updating existing contracts that cite LIBOR as the reference rate and encouraging the issuance of new products that use SOFR. The ARRC has supported the issuance of SOFR-linked products and securities. Recognizing the importance of updating existing contracts that use LIBOR as a reference rate, the ARRC has developed guiding principles for fallback contract language. Following this, the ARRC released recommended fallback contract language for several products including adjustable-rate mortgages and floating-rate notes.
On November 15, 2019, Fannie Mae and Freddie Mac announced their support of the ARRC’s fallback language and their plan to incorporate the recommended language into its uniform notes and other legal documents for ARMs. They also announced their plan to offer new SOFR-based index and ARM products and have now become regular issuers of SOFR-indexed debt. Similarly, on February 5, 2020, Fannie Mae and Freddie Mac announced that they had incorporated the ARRC’s fallback language into their existing standard ARM notes and riders. Further, they announced that, by the end of 2020, they will no longer acquire loans indexed to LIBOR.
In November 2020, the Federal Reserve System, OCC, and FDIC released a joint statement explaining that they would not be endorsing a specific replacement rate for LIBOR loans because institutions should select a reference rate that they determine is appropriate based on their funding model and customer needs.
Planning for the End
Given either the upcoming end or instability of LIBOR, financial institutions should prepare for 2022 and June 2023. Institutions should ensure they have comprehensively assessed their risks and develop an action plan to mitigate those risks. It might be best to appoint one person to head the financial institution’s strategy and implementation. First, financial institutions should review their existing agreements that use LIBOR as a reference rate. The existing agreements should be divided into those in which a third party is involved, i.e., trust preferred securities or swap agreements, and those in which the financial institution and the other contracting party are the only parties to the transaction (the In-House Contracts).
Any financial institutions that have issued debt securities (such as subordinated debt or trust preferred securities) at the holding company or bank level should check the documentation governing those issuances. Typically, those contracts provide for the substitution of a comparable rate. Financial institutions should confirm the substitution language and also review the procedures for substituting the rate. If the issuance involves an institutional trustee, such as Wilmington Trust Company for many outstanding trust preferred securities, it may be necessary or advisable to contact the institutional trustee far in advance of the LIBOR end to discuss the process of changing rates.
The In-House Contracts should be further subdivided by the LIBOR rate that is used (one-week, two-month, 12-month, etc.). In-House Contracts using one-week and two-month LIBOR as a reference rate should be subdivided into those whose term ends prior to the end of 2021 and those whose maturity is after 2021. In-House Contracts using the other LIBOR tenors should be subdivided into those whose term ends prior to the end of 2023 and those whose maturity is after 2023.
Next, financial institutions should ensure that existing In-House Contracts are able to substitute a comparable rate. Then, the financial institution should determine whether it will substitute a new rate and a new margin and at what point the change will be made. Consideration should be given to the stability of a new rate and a new margin. The decision on a new rate and a new margin may involve several committees and personnel at the financial institution as different considerations of interest rate risk, stability, competition and other factors will influence the ultimate substitute reference rate the financial institution will utilize. In assessing a rate, financial institutions should consider their funding costs and their customers’ needs. With respect to variable rate consumer loans, financial institutions should consider their notice requirements under the contract and disclosure requirements under Regulation Z. For variable rate consumer loans, financial institutions should ensure that they select a rate that is considered comparable to LIBOR. Financial institutions should note that the Prime Rate will continue to be available unaffected by the impending demise of LIBOR.
After a decision has been made on the financial institution’s new reference rate, it may be advisable to educate the financial institution’s LIBOR customers on the new rate, especially if it is a rate that customers may not be familiar with. Although a customer may not have the right to contest the new reference rate, educating the customer may alleviate the customer’s anxiety about the new reference rate.
Finally, the financial institution should determine how the new reference rate will be implemented. The financial institution should consider whether it will draft amendments to existing loan documents to implement the new reference rate or whether it will simply notify the other party to the contract of the new reference rate. Financial institutions should contact their legal counsel for advice on this issue.
The WBA forms distributed through FIPCO currently contain a provision that if the index rate a lender uses with respect to a particular loan becomes unavailable then the lender may substitute a comparable index rate. To alleviate concerns with the zombie LIBOR, FIPCO has created the LIBOR Addendum. This Addendum allows the lender to replace LIBOR if a “Replacement Event” occurs. The Addendum is drafted to define a Replacement Event to include a situation in which LIBOR would continue to exist in a zombie state. The LIBOR Addendum can be used for new loans that use LIBOR as the index rate. The form could also be used for existing loans, but the borrower is required to sign the LIBOR Addendum.
Financial institutions should stop using LIBOR as a reference rate in new contracts as soon as practicable, and, in any event by December 31, 2021. When making new loans that use LIBOR as a reference rate, financial institutions should ensure that any new contracts include robust fallback language that will allow for an easy transition to a new reference rate. Consideration should be given to using the LIBOR Addendum to In-House Contracts. Additionally, financial institutions should consider incorporating the fallback language adopted by Fannie Mae and Freddie Mac to any residential real estate mortgages using LIBOR intended to be sold on the secondary market.
Taking the steps outlined above will help financial institutions mitigate their risks in the post-LIBOR market.
Boardman and Clark is a WBA Gold Associate Member.

Amendments to facilitate transition to new index

Q: Has CFPB Proposed Changes to Facilitate the LIBOR Transition?

A: Yes. CFPB has Proposed Changes to Regulation Z that Generally Become Effective on March 15, 2021.

Sometime after 2021, LIBOR is expected to end. Financial institutions are developing their approach to the LIBOR transition, including how to transition existing accounts from LIBOR to another index and selecting new indices for new originations going forward. This includes documentary and contractual considerations, and for certain consumer financial products and services, statutes and regulations may have requirements that are triggered or impacted by the LIBOR transition and any accompanying index change.

The Consumer Financial Protection Bureau (CFPB) has issued a proposed rule (proposal) to amend Regulation Z to facilitate the LIBOR transition for open-end and closed-end credit. A high-level summary of some select provisions are featured below.

For HELOCs, open-end reverse mortgages, and credit cards the proposal would:

  • Require the change-in-terms notice to include the replacement index and any adjusted margin, regardless of whether the margin is being reduced or increased. 
  • Permit creditors to transition from LIBOR on or after March 15, 2021 (in addition to the option of using the current "no longer available" standard). 
  • Identify December 31, 2020, as the date used for selecting the index values for the LIBOR index and the replacement index to compare the rates, rather than using the index values on the date the original index becomes unavailable.

For closed-end mortgages, student loans, and other closed-end consumer loans the proposal would:

  • Provide an example of an index that is a "comparable index" to LIBOR for closed-end products in order to assist in determining whether a transaction must be completed as a refinance. 

In addition to the proposal, CFPB has published a fact sheet and FAQ to help understand the regulatory effect of the LIBOR transition.

CFPB's proposed rule

CFPB's FAQ

CFPB's Fast Facts

Birrenkott is WBA assistant director – legal. For legal questions, please email wbalegal@wisbank.com.

Note: The above information is not intended to provide legal advice; rather, it is intended to provide general information about banking issues. Consult your institution's attorney for special legal advice or assistance.

By, Amber Seitz

On June 4, 2020 the Consumer Financial Protection Bureau (CFPB) released a notice of proposed rulemaking (proposal) to address the sunset of LIBOR, which is expected to be discontinued after 2021. The proposal would provide examples of replacement indices that meet certain Regulation Z (Reg Z) standards, permit creditors new means to transition home equity lines of credit and credit card accounts from LIBOR to a replacement index, and address change-in-terms notice provisions.

Reg Z contains separate provisions for open-end credit that is home secured and open-end credit that is not home secured. These distinctions are important for identifying applicability of various rules, and the proposal amends each separate rule appropriately. However, from a conceptual standpoint, the changes are fundamentally similar. To present these fundamental changes in a manner that is simpler to understand from a conceptual standpoint, and to avoid redundancy, provisions for open-end home-secured and not home-secured plans have been presented together.

Open-end Credit Subsequent Disclosure Requirements

Reg Z specifies when change-in-terms notifications must be sent to consumers. The transition from LIBOR may trigger certain notification requirements, which CFPB seeks to clarify in the proposal. For example, the proposal would specify that any change-in-terms notice must include any replacement index, including any adjusted margin, regardless of whether the margin is reduced or increased. Reg Z Section 1026.9(c) contains rules for when written change-in-terms notifications are required, both for open-end credit plans secured by the consumer’s dwelling and open-end not home-secured plans. Those rules can be summarized in a way that is relevant to the proposal as follows:1

  • For open-end credit plans secured by the consumer’s dwelling, a creditor must provide a notice whenever a term required to be disclosed (required term) is changed, or the required minimum periodic payment is increased.
  • For open-end (not home-secured) plans, a creditor must provide a notice whenever a significant change in required account terms is made.
  • Both rules provide an exception from notice requirements when the change involves a reduction of any component of a finance or other charge.

Because the index is a required term, a creditor must provide a change-in-terms notice disclosing the index that is replacing the LIBOR index for both open-end credit plans secured by the consumer’s dwelling and for non-home-secured plans. The exception does not apply to the index change, regardless of whether there is also a change in the index value or margin that involves a reduction in a finance or other charge.

Reg Z currently requires notification of a margin change if the margin is increasing. However, a decrease in the margin would be excepted from the notification requirements because the change would involve a reduction in a component of a finance or other charge. The proposal would revise the exception when the change involves a reduction of any component of a finance or other charge so that it does not apply on or after Oct. 1, 2021, where the creditor is reducing the margin when a LIBOR index is replaced. Thus, the proposal would make it clear that a change-in-terms notice for any replacement index must include any adjusted margin regardless of whether the margin is reduced or increased.

The Truth in Lending Act generally requires that changes in disclosures have an effective date of the 1st of October that is at least six months after the date the final rule is adopted. However, in the proposal, CFPB notes that creditors may want to provide the information about the decreased margin in the change-in-terms notice even if they replace the LIBOR index and adjust the margin earlier than Oct. 1, 2021.

Requirements for Home Equity Plans and Credit Cards

Reg Z generally prohibits a creditor from changing the terms of a HELOC except under certain circumstances. Additionally, Reg Z Subpart G contains rules implementing requirements under the Credit CARD Act. In the case of a credit card account under an open-end consumer credit plan, a card issuer may not increase an APR (or certain other charges) except under certain circumstances.

Existing unavailability provisions exist for both HELOC plans and credit card plans, which permits the creditor to change the index and margin. In both instances, the proposal would revise existing unavailability provisions, primarily for technical, conforming, and clarification purposes. The proposal would also create LIBOR-specific provisions and permit a creditor to use either those new provisions or the existing, updated unavailability provisions.

Reg Z currently provides that a creditor may change the index and margin used under either plan under certain circumstances, namely beginning with the situation where the original index has become no longer available. The proposal would update both existing unavailability provisions so that a creditor may change the index and margin used under the plan if the original index is no longer available, the replacement index has historical fluctuations substantially similar to that of the original index, and the replacement index and replacement margin would have resulted in an APR substantially similar to the rate in effect at the time the original index became unavailable. The proposal would also provide that if the replacement index is newly established and therefore does not have any rate history, it may be used if it and the replacement margin will produce an APR substantially similar to the rate in effect when the original index became unavailable. Thus, the proposal would change the existing requirements in the following three ways:

  1. Using the term “historical fluctuations” rather than the term “historical movement” to refer to the original index and the replacement index. This would primarily be a technical change with the revised definition being shaped by conforming changes throughout the rule.
  2. Including a provision regarding newly established indices. A similar provision currently exists in Reg Z requiring newly established indices to produce a rate substantially similar to the original index. The proposal would clarify that the creditor using a newly established index may adjust the margin in order to produce a substantially similar APR.
  3. The terms “replacement index” and “replacement index and replacement margin” are used instead of “new index” and “new index and margin.” This proposed change is intended to avoid any confusion when the rule refers to a replacement index and replacement margin as opposed to a newly established index.

The proposal would also add new LIBOR-specific provisions to Reg Z. These provisions would permit creditors for both types of plans that use a LIBOR index under the plan to replace the LIBOR index and change the margins for calculating the variable rates on or after March 15, 2021, under certain circumstances, without needing to wait for LIBOR to become unavailable.

Specifically, the proposal would provide that if a variable rate is calculated using a LIBOR index, a creditor may replace the LIBOR index and change the margin for calculating the variable rate on or after March 15, 2021, as long as:

  1. The historical fluctuations in the LIBOR index and replacement index were substantially similar; and
  2. The replacement index value in effect on Dec. 31, 2020, and replacement margin will produce an APR substantially similar to the rate calculated using the LIBOR index value in effect on Dec. 31, 2020, and the margin that applied to the variable rate immediately prior to the replacement of the LIBOR index used under the plan.

Additionally, if the replacement index is newly established and therefore does not have any rate history, it may be used if the replacement index value in effect on December 31, 2020, and the replacement margin will produce an APR substantially similar to the rate calculated using the LIBOR index value in effect on Dec. 31, 2020, and the margin that applied to the variable rate immediately prior to the replacement of the LIBOR index used under the plan.

Card Issuer Reevaluation of Rate Increases

Reg Z contains provisions that requires a card issuer to perform an ongoing review for credit card accounts when an APR is increased. Thus, if the LIBOR transition results in an APR increase, a card issuer would be required to complete an analysis reevaluating the rate on that account every 6 months until certain requirements are met. For this purpose, LIBOR must be used as the comparison index.

The proposal would create an exception for those card issuers that transitioned from LIBOR using either Reg Z’s existing unavailability provision, or the proposal’s LIBOR-specific provision discussed above. The proposal also would provide instructions on how to replace LIBOR as a benchmark for comparison for card issuers who were already required to perform a review as of March 15, 2021.

Where the transition results in an APR increase, no analysis reevaluating the rate would be required. The proposal also would provide instructions on how to replace LIBOR as a benchmark for comparison for card issuers who were already required to perform a §1026.59 review as of March 15, 2021.

Closed-end Considerations

Pursuant to Reg Z, if a creditor changes the index of a variable-rate closed-end loan to an index that is not a “comparable index,” the index change may constitute a refinancing for purposes of Regulation Z, triggering certain requirements. The proposal would provide an example of an index that is a “comparable index” to LIBOR for closed-end products. Specifically, CFPB would add an illustrative example to identify the Secured Overnight Financing Rate-based spread-adjusted replacement indices recommended by the Alternative Reference Rates Committee as an example of a “comparable index” for the LIBOR indices that they are intended to replace.

Conclusion

CFPB’s proposal would provide examples of replacement indices for LIBOR, permit a means for creditors to transition existing accounts that use LIBOR to a replacement index, address change-in-terms notice provisions, and address the rate reevaluation provisions applicable to credit card accounts. Financial institutions using LIBOR as an index for calculating rates for open-end and closed-end products should consider how these changes affect their plans for the transition to replacement indices. As noted above, this article has been presented to understand the proposal on a conceptual level. As such, financial institutions should refer to the applicable provisions within the proposal itself depending on the types of products they offer for more specific requirements. CFPB has also provided FAQs (which includes other transition topics in addition to the proposal) and “fast facts” regarding the proposal. 

Questions can also be directed to the WBA Legal Call program at wbalegal@wisbank.com.

CFPB’s Proposed Rule
FAQ
Fast Facts

Birrenkott is WBA assistant director – legal. 

Note: The above information is not intended to provide legal advice; rather, it is intended to provide general information about banking issues. Consult your institution's attorney for special legal advice or assistance.

The requirements as presented in this article are summarized to better present the proposal and do not represent an accurate summary of requirements in their totality. See Reg Z Sections 1026.9(c)(1) and 1026.9(c)(2) for the full requirements. 

By, Amber Seitz