The Bureau's Final Rule Under Regulation Z to Address LIBOR's Sunset
On December 7, 2021, the Consumer Financial Protection Bureau (Bureau) issued a final rule under Regulation Z to address the sunset of the London Interbank Offered Rate (LIBOR) on consumer credit cards, home equity lines of credit (HELOCs), and closed-end, variable-rate loans using LIBOR as a reference rate.1 The rule generally became effective on April 1, 2022, although compliance with some provisions is not required until later dates. This article summarizes the rule.
Background
LIBOR, which is calculated “by polling more than a dozen large global banks in London about the interest rate at which they can borrow for various lengths of time (‘tenors’) in U.S. dollars and four other currencies,”2 is a key benchmark in many variable-rate, consumer credit products, including closed-end mortgages, HELOCs, reverse mortgages, credit cards, and student loans. The Congressional Research Service estimates that LIBOR was referenced in approximately $223 trillion of financial instruments as of 2020.3
LIBOR’s future came into question in 2012 when a scandal revealed that some of the panel banks were manipulating their LIBOR submissions for financial gain and to mask their financial condition during the financial crisis.4 In response, the Financial Stability Board issued a report in 2014 titled Reforming Major Interest Rate Benchmarks that recommended transitioning from LIBOR to alternative benchmarks.5 In November 2020, the ICE Benchmark Administration, LIBOR’s administrator, announced its intention to consult with the Financial Conduct Authority, LIBOR’s regulator, on ending LIBOR after December 31, 2021, for the one-week and two-month U.S. dollar (USD) tenors, and after June 30, 2023, for the remaining overnight, one-month, three-month, six-month, and 12-month USD tenors.6 The ICE LIBOR® Feedback Statement on Consultation on Potential Cessation, in explaining the different expiration dates, noted that the one-week and two-month tenors are not as widely used as the remaining tenors.7
Secured Overnight Financing Rate (SOFR)
In 2014, as regulators explored alternatives to LIBOR, the Federal Reserve Board (Board) and the Federal Reserve Bank of New York (FRBNY) jointly convened the Alternative Reference Rates Committee (ARRC), with the goals of identifying and implementing risk-free alternative rates for the USD LIBOR.8 In 2017, the ARRC announced the Secured Overnight Financing Rate (SOFR) as an alternative benchmark, which broadly measures the cost of borrowing cash overnight collateralized by Treasury securities and is published daily on the FRBNY’s website.9
In November 2020, the Board, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (agencies) encouraged supervised institutions to stop entering into new contracts that use LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021. The guidance also recommended that financial instruments entered into before December 31, 2021, should either use a reference rate other than LIBOR or have robust fallback language with a clearly defined alternative reference rate after LIBOR is discontinued.10 In October 2021, the agencies issued additional supervisory guidance to facilitate the transition from LIBOR.11
Against this backdrop of supervisory guidance for creditors to phase out LIBOR in their financial instruments, the Bureau’s final rule provides the framework under Regulation Z for implementing this change for consumer credit. The rule primarily addresses 1) replacement indexes for variable-rate products, 2) change-in-terms notices (CITN), and 3) reevaluations of credit card rate increases.
Replacement Indexes
HELOCs and Credit Cards
The Bureau’s final rule generally provides HELOC creditors and credit card issuers with the option of 1) waiting until the LIBOR indexes specified in their instruments are no longer available, or 2) to begin transitioning from the LIBOR index to a replacement index on or after April 1, 2022. Currently, Regulation Z only permits an index change for these products when the original index is no longer available. 12The final rule thus provides flexibility to creditors seeking to replace LIBOR before it is no longer available.
For both credit cards and HELOCs, if the creditor replaces the LIBOR index before it becomes unavailable, the replacement index must meet the following standards:
- Historical fluctuations in the LIBOR index and replacement index are substantially similar.13
- The replacement index and replacement margin produce an annual percentage rate (APR) substantially similar to the APR based on adding the LIBOR index in effect on October 18, 2021, to the account’s existing margin.14
The commentary includes this example to illustrate a HELOC that uses a replacement index and replacement margin that result in an APR substantially similar to the rate calculated using the LIBOR index:
Assume a variable rate used under the plan that is based on the 1-month U.S. Dollar LIBOR index and assume that LIBOR becomes unavailable after June 30, 2023. On October 18, 2021, the LIBOR index value is 2%, the margin on that day is 10% and the annual percentage rate using that index value and margin is 12%. Assume on January 1, 2022, a creditor provides a change-in-terms notice under §1026.9(c)(1) disclosing a new margin of 12% for the variable rate pursuant to a written agreement under §1026.40(f)(3)(iii), and this change in the margin becomes effective on January 1, 2022, pursuant to §1026.9(c)(1). Assume that there are no more changes in the margin that is used in calculating the variable rate prior to April 1, 2022, the date on which the creditor provides a change-in-terms notice under §1026.9(c)(1), disclosing the replacement index and replacement margin for the variable rate that will be effective on April 17, 2022. In this case, the margin that applied to the variable rate immediately prior to the replacement of the LIBOR index used under the plan is 12%. Assume that the creditor has selected the prime index published in the Wall Street Journal as the replacement index, and the value of the prime index is 5% on October 18, 2021. A replacement margin of 9% is permissible under §1026.40(f)(3)(ii)(B) because that replacement margin combined with the prime index value of 5% on October 18, 2021, will produce an annual percentage rate of 14%, which is substantially similar to the 14% annual percentage rate calculated using the LIBOR index value in effect on October 18, 2021, (which is 2%) and the margin that applied to the variable rate immediately prior to the replacement of the LIBOR index used under the plan (which is 12%). (Emphasis added).15
What If the Creditor Waits Until the LIBOR Index Is No Longer Available?
In that circumstance, the replacement index must have historical fluctuations substantially similar to the original index. In addition, the replacement index and margin must result in an APR substantially similar to the APR in effect before the original index “became unavailable.”16 But the regulation does not define when an index is no longer available.
What If the Replacement Index Has No Rate History?
A new replacement index with no rate history generally can be used if its value on October 18, 2021, plus its replacement margin, will produce an APR substantially similar to the APR under the LIBOR index in effect on October 18, 2021, or the next calendar day if the replacement index is not available on October 18.17
Safe Harbor
To facilitate compliance, the final rule provides a safe harbor to replace the LIBOR index for HELOCs and credit cards with either the prime rate published in the Wall Street Journal or the SOFR, provided certain other requirements are satisfied.18
Refinancing of a Closed-end Variable Rate Loan
For closed-end variable-rate loans, a change in the index could constitute a refinancing under §1026.20(a), which would trigger new Regulation Z disclosures and certain other requirements.19 A refinancing occurs if the replacement index is not comparable with the existing index.20 Comment 20(a)-3.iv lists the relevant factors to determine if the new index is comparable, including (but not limited to) whether:
- the movements over time are comparable;
- the consumers’ payments using the replacement index compared with payments using the LIBOR index are comparable if there is sufficient data for this analysis;
- the index levels are comparable;
- the replacement index is publicly available; and
- the replacement index is outside the control of the creditor.
The comment also notes that “these determinations may need to consider certain aspects of the historical data itself for a particular replacement index, such as whether the replacement index is a backward-looking rate (e.g., historical average of rates) such that timing aspects of the data may need to be adjusted to match up with the particular forward-looking LIBOR term-rate being replaced.”
Safe Harbor
The commentary includes a safe harbor for replacing the index of a variable-rate loan with a USD LIBOR index for a one-month, three-month, or six-month tenor.21 The Bureau did not include the LIBOR one-year tenor because ARCC has not yet released the corresponding SOFR. “Once the Bureau knows which SOFR-based spread adjusted index the ARRC will recommend to replace the one-year USD LIBOR index for consumer products, the Bureau may determine whether that index meets the ‘comparable’ standard based on information available at that time.”22
Change-in-Terms Notice
Regulation Z requires advance notices for certain changes to open-end consumer credit agreements.23 The final rule addresses how this provision applies to HELOCs and credit cards transitioning from LIBOR to a replacement index.
Credit Cards
Creditors for open-end, nonhome secured credit generally must provide a CITN for certain changes at least 45 days prior to the change.24 The final rule clarifies that when a card issuer changes the reference index, it must disclose the new index as well as the margin 45 days prior to the change, regardless of whether the new index or the margin increases or decreases the finance or other charges.25
CITN Credit Card Formatting Requirements
The notice must be in a tabular format that discloses:
- the amount of the new rate based on the new index;
- that it can vary; and
- how it is determined.26
In addition, if the rate with the replacement index will increase when the CITN is provided, a creditor must disclose the new periodic rate and APR calculated using the replacement index.27
HELOCs
A CITN is required whenever any term required to be disclosed under §1026.6(a) is changed, or the required minimum periodic payment is increased, at least 15 days prior to the effective date of the change.28 Under the final rule, creditors must provide notice of the index replacement, as well as any change in the margin.29 Regulation Z currently does not require a CITN if a change reduces the finance charge or any other charge. The final rule amends this to require a CITN when an index is replaced, even if the margin decreases.30 The format requirements for the CITN described previously for credit cards do not apply to HELOCs.31
Credit Card Rate Reevaluation Requirements
Regulation Z generally requires that if a card issuer increases a consumer’s rate, it must evaluate the increase at least every six months to see if the consumer qualifies for a lower rate.32 The final rule provides this requirement will not apply if the rate increased because a LIBOR index was replaced in accordance with the rule. Rate increases effective prior to the replacement of a LIBOR index are not covered by this exception.33
Conclusion
As affected creditors begin the process of transitioning from the LIBOR index for their variable-rate consumer credit agreements to a replacement index, the Bureau’s final rule, and accompanying resources, providing a detailed roadmap and framework to implement these changes. Specific issues and questions should be raised with your primary regulator.
Resources
Regulation Z LIBOR Transition Final Rule
LIBOR Transition FAQs
Executive Summary of the 2021 LIBOR Transition Rule
ENDNOTES
1 See 86 Federal Register 69716 (December 8, 2021).
2 See “The LIBOR Transition,” Congressional Research Service (December 15, 2021).
3 See “The LIBOR Transition,” p. 1.
4 See “The LIBOR Transition,” p. 1.
5 See Reforming Major Interest Rate Benchmarks, Financial Stability Board (July 22, 2014).
6 See “ICE Benchmark Administration to Consult on Its Intention to Cease the Publication of One Week and Two Month USD LIBOR Settings at End-December 2021, and the Remaining USD LIBOR Settings at End-June 2023” (November 30, 2020).
7 See ICE LIBOR Feedback Statement on Consultation on Potential Cessation, ICE Benchmark Administration, March 5, 2021.
8 See ARCC.
9 See “Secured Overnight Financing Rate Data,” Federal Reserve Bank of New York. The ARCC website provides additional information about SOFR.
10 See SR 20-27: Interagency Statement on LIBOR Transition (November 30, 2020).
11 See SR 21-17 / CA 21-15: Interagency Statement on Managing the LIBOR Transition (October 22, 2021).
12 See 12 C.F.R. §1026.40(f)(3)(ii)(A) for HELOCs and §1026.55(b)(7)(i) for credit cards.
13 Comments 40(f)(3)(ii)(B)-1.iii and 55(b)(7)(ii)-1.iii address the factors to determine whether a replacement index has historical fluctuations substantially similar to a LIBOR index, for HELOCs and credit cards, respectively.
14 See 12 C.F.R. §1026.40(f)(3)(ii)(B) and commentary for HELOCs, and §1026.55(b)(7)(ii) and commentary for credit cards.
15 See Comment 40(f)(3)(ii)(B)-2.i.
16 See 12 C.F.R. §1026.40(f)(3)(ii)(A) for HELOCs and 12 C.F.R. §1026.55(b)(7)(i) for credit cards.
17 See 12 C.F.R. §1026.40(f)(3)(ii)(A) for HELOCs and 12 C.F.R. §1026.55(b)(7)(ii) for credit cards.
18 See Comments 40(f)(3)(ii)(B)-1 for HELOCs and 55(b)(7)(i)-1 for credit cards.
19 See 12 C.F.R. §1026.20(a).
21 See Comment 20(a)-3.ii.B.
22 See 86 Federal Register at 69730.
23 See 12 C.F.R. §1026.9(c).
24 See 12 C.F.R. §1026.9(c)(2). An exception applies to the 45-day period if the consumer agrees to the change. See 12 C.F.R. §1026.9(c)(2)(i)(A).
25 See 86 Federal Register at 69725 (codified at 12 C.F.R. §1026.9(c)(2)(v)(A)) and Comment 9(c)(2)(v)-14. The Bureau also clarified while notices are generally not required for rate changes to a variable rate loan based on an index not under the creditor’s control, that exception does not apply here because the index is being replaced. 86 Federal Register at 69725.
26 See 86 Federal Register at 69725.
27 See 86 Federal Register at 69725.
28 See 12 C.F.R. §1026.9(c)(1)(i). If the consumer consents to the change, the notice must still be provided, but can be delivered as late as the effective date. Comment 9(c)(1)(i)-3.
29 See Comment 9(c)(1)(ii)-3.
30 See 12 C.F.R. §1026.9(c)(1)(ii) and Comment 9(c)(1)(ii)-3.
31 Regulation Z imposes one set of CITN requirements for HELOCs at 12 C.F.R. §1026.9(c)(1) and a different set of requirements for nonhome secured, open-end credit at §1026.9(c)(2). The specific CITN formatting requirements for nonhome secured credit CITNs at §1026.9(c)(2)(iv)(D) are not required for HELOCs. The Board issued a rulemaking proposal for HELOCs in 2009, when it still had general rulemaking authority for Regulation Z, that included tabular format requirements for certain HELOC CITNs. 74 Federal Register 43428, 43542 (August 26, 2009). However, in 2011, the Board announced it would not proceed with this proposal because of the transfer of rulemaking authority to the Bureau.
32 See 12 C.F.R. §1026.59.
33 See 12 C.F.R. §1026.59(h)(3).