The Fed’s Holiday Gift – Final LIBOR Regulations

On Friday, December 16, the Federal Reserve Board (Board) adopted the long-awaited final rule implementing the Adjustable Interest Rate (LIBOR) Act, 12 U.S.C. §§ 5801 et seq. (the LIBOR Act). The final rule identifies SOFR-based benchmark rates that will replace LIBOR in US contracts covered by the LIBOR Act after June 30, 2023. The final rule becomes effective 30 days after its publication in the Federal Register. The final rule largely tracks the statutory language of the LIBOR Act and the proposed rule published on July 28, 2022, but contains several revisions prompted by comments. The noteworthy inclusions and omissions are identified below:

Determining Persons

• In the final rule, the Board interpreted and expanded the statutory term, “determining person,” to include those who have a temporary or contingent contractual right to determine a LIBOR replacement, such as those whose replacement authority arises only when LIBOR ends or becomes non-representative. This interpretation gives such “determining persons” the ability to choose the Board-selected replacement by the earlier of the LIBOR replacement date under the LIBOR Act or the latest date for selecting a replacement under the LIBOR contract irrespective of when their authority to replace LIBOR actually arises. They need not wait until LIBOR ends to afford themselves of the protections afforded by the statute. Earlier decision-making will lead to a smoother transition, according to the Board.
• The Board narrowed the statutory term “determining person” to mean a person that has the “sole” replacement authority under a LIBOR contract. This change was made in response to a comment requesting clarity that a “determining person” would not include a person who is required under the LIBOR contract to collaborate with other persons. This change may require additional analysis in the context of securitizations and additional contracts that have trustees, calculation agents or servicers with authority to collaborate in making a determination.

Covered versus Non-Covered Contracts

The final rule removed the distinction between a “covered contract” and a “non-covered contract,” which is a welcome change from the proposed rule. The change was prompted by comments that the covered/non-covered definitions did not align with the provisions of the LIBOR Act and were confusing.

Eurodollar Lending

The statute renders null and void any fallback provision in a LIBOR contract requiring that a LIBOR rate be determined by polling lenders. The final rule clarifies that contracts containing provisions calling for polling of Eurodollar deposit and lending rates will also be null and void after the LIBOR cessation date. The final rule further notes that, because such contracts contain polling provisions but do not typically specify a replacement rate (e.g., prime), the determining persons for those contracts may select the Board-selected benchmark under § 5803 of the statute.

Synthetic LIBOR

Commentors raised concerns regarding contracts that provide for LIBOR replacement when LIBOR is unavailable but lack a nonrepresentative trigger. If the UK Financial Conduct Authority compels publication of a synthetic USD LIBOR, the synthetic rate will no longer be representative, but will continue to be published as “LIBOR.” The Board addressed these concerns by concluding that determining persons with the contingent authority to choose a LIBOR replacement when LIBOR becomes unavailable can select the Board-selected replacement in accordance with the statute regardless of whether a synthetic LIBOR is available. 

The Board noted as follows:

• Based on the statutory language, “LIBOR contracts containing fallback provisions that identify a specific benchmark replacement are outside the scope of the LIBOR Act, even if these fallback provisions lack an express non-representativeness trigger.” For example, a contract that falls back to the prime rate when LIBOR ends is outside the scope of the LIBOR Act (regardless of whether the fall back occurs when LIBOR “ceases,” “becomes unavailable” or becomes “nonrepresentative”).
• However, where a LIBOR contract has no specified fall back rate, but has a determining person with contingent authority (as discussed under “Determining Persons” above) to choose a replacement rate when LIBOR is unavailable, then that person can select the Board-selected replacement in accordance with the LIBOR Act even if synthetic LIBOR is published. If the determining person does not select a benchmark replacement by June 30, 2023, the applicable Board-selected benchmark replacement will be automatic.
• The Board notes that the statute does not accelerate a determining person’s contingent right under a LIBOR contract to select a benchmark replacement other than the Board-selected benchmark replacement. This means that if a contract provides for prime as a fallback, but contains no nonrepresentative trigger, the applicable rate would be synthetic LIBOR as long as synthetic LIBOR is available.

Board-Selected Replacement Rates

Subject to certain carve outs, the final rule confirms that one-, three-, six- and twelve-month Term SOFR, administered by CME Group Benchmark Administration Ltd., plus the statutory spread adjustments (also incorporated directly into the rule) are the Board-selected replacement rates for cash products. Derivative, FHFA-regulated-entity and FFELP contracts are treated differently. 

• For a LIBOR contract that is a derivative transaction, the “Fallback Rate (SOFR)” is defined in the 2020 IBOR Fallbacks Protocol published by the International Swaps and Derivatives Association (ISDA protocol), which incorporates the statutorily prescribed tenor spread adjustment.
• In response to comments, the final rule includes technical amendments to ensure that calculations match precisely the manner in which SOFR is calculated under the ISDA protocol, including by adding a “derivative transaction fallback observation day” to match the ISDA term.
• The Structured Finance Association requested that for derivative transactions linked to certain securitizations, the board-selected benchmark replacement be the same as for the related securities. The Board noted, however, that promoting use of a consistent approach to replace LIBOR references in derivative transactions should enhance financial stability and that the proposed approach was consistent with the recommendations of the ARRC.
• For a LIBOR contract that is an FHFA-regulated-entity contract:
  • for Federal Home Loan Bank advances, the “Fallback Rate (SOFR)” as defined in the ISDA protocol; and
  • for all other FHFA-regulated-entity contracts, SOFR (in place of overnight LIBOR) or 30-day compounded average SOFR published by FRBNY (“30-day Average SOFR,” in place of one-, three-, six- or 12-month LIBOR), plus the applicable statutorily prescribed tenor spread adjustment.
    • this affirms that Freddie Mac and Fannie Mae will be allowed to continue using an index based on a 30-day Average SOFR.
• For a LIBOR contract that is a FFELP ABS, either (i) 30-day Average SOFR (for one-, six- and 12-month LIBOR) or (ii) 90-day compounded average SOFR published by FRBNY (for three-month LIBOR), plus the applicable statutorily prescribed tenor spread adjustment.
• The benchmark replacement rate for consumer loans, equal to (i) CME Term SOFR and (ii) the transition tenor spread adjustment (for the one-year period beginning on the LIBOR replacement date) or the tenor spread adjustment date (after that one-year period) will be published by Refinitiv Limited, consistent with the proposed rule and recommendations from AARC.

Hunton Andrews Kurth LLP’s multi-disciplinary LIBOR transition client service team is available to assist clients navigating LIBOR transition, including consideration of and drafting for term SOFR and other replacement rates. For further information, contact any of the related people.