Proposed federal LIBOR transition regulations

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.