Federal Reserve Board Adopts Final Version Of LIBOR Transition Rule – Financial Services

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.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.