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Background and Summary of Regulation ZZ

3-4265

LIBOR

Formerly known as the London interbank offered rate, LIBOR is an interest rate benchmark that was the dominant reference rate used in financial contracts in recent decades, serving as the benchmark rate in more than $200 trillion worth of contracts worldwide.1 While over-the-counter and exchange-traded derivatives account for the vast majority of this estimated exposure to LIBOR, LIBOR is also referenced in trillions of dollars’ worth of business and consumer loans, bonds, securitizations, and nonfinancial corporate contracts.
LIBOR is intended to reflect the rate at which large banks can borrow wholesale funds on an unsecured basis. LIBOR is calculated based on submissions contributed by a panel of large, globally active banks (LIBOR panel banks). Until December 31, 2021, LIBOR’s administrator calculated and published LIBOR each London business day for five currencies (USD, GBP, EUR, CHF, and JPY) and seven borrowing periods, known as tenors (overnight, one week, one month, two months, three months, six months, and twelve months).
Over the past decade, financial regulators have expressed growing concern regarding the structural vulnerabilities and robustness of LIBOR.2 Following the financial crisis of 2007-2009, other forms of borrowing have largely replaced short-term unsecured wholesale borrowing as a source of funds for most banks, resulting in far fewer market transactions on which LIBOR panel banks can base their submissions. At the same time, weaknesses in the governance of LIBOR created the opportunity for LIBOR panel banks to manipulate LIBOR, and numerous high-profile examples of such manipulation were exposed.3 Following these scandals, in 2013, the administration of LIBOR was transferred to a new administrator, ICE Benchmark Administration Limited (IBA), which is regulated by the U.K.’s Financial Conduct Authority (FCA).
Despite increased regulatory oversight and efforts to improve LIBOR, confidence in LIBOR continued to wane, and financial regulators and market participants began to search for alternative reference rates and develop plans for a transition away from LIBOR. In the United States, this effort has been led by the Alternative Reference Rates Committee (ARRC), a group of private-sector firms convened jointly by the Board and the Federal Reserve Bank of New York (FRBNY) in 2014.4 Among other work, the ARRC identified the Secured Overnight Financing Rate (SOFR) as its recommended replacement for USD LIBOR and developed a Paced Transition Plan to support the transition from USD LIBOR to SOFR.5 SOFR is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities.6 Similar groups were convened in other jurisdictions and identified comparable risk-free rates as recommended replacements for the other LIBOR currencies.
In July 2017, following the departure of some panel banks, the FCA announced that the remaining LIBOR panel banks had voluntarily agreed to sustain LIBOR through the end of 2021 to facilitate an orderly transition away from LIBOR.7 On March 5, 2021, the FCA announced that, after December 31, 2021, IBA would cease publishing 24 currency and tenor pairs (known as settings). The discontinued LIBOR settings included one-week and two-month USD LIBOR, as well as all EUR and CHF LIBOR tenors and most GBP and JPY LIBOR tenors.8 However, the FCA required IBA to continue publishing, on a temporary basis, certain GBP and JPY LIBOR tenors on a “synthetic” basis, stating that any such synthetic LIBOR settings “will no longer be representative of the underlying market and economic reality the setting is intended to measure.”9
To allow most legacy USD LIBOR contracts governed by non-U.S. law to mature without disruption, the FCA also announced that the panels for the remaining five tenors of USD LIBOR would continue through, but cease after, June 30, 2023. The FCA has proposed to require IBA to continue publishing one-, three-, or six-month USD LIBOR on a synthetic basis until the end of September 2024 (synthetic LIBOR).10 As with synthetic GBP or JPY LIBOR settings, the FCA has announced that synthetic LIBOR settings are “not representative of the markets that the original LIBOR settings were intended to measure.”11
In response to the planned cessation of USD LIBOR, U.S. financial regulators have encouraged market participants to transition away from USD LIBOR as a reference rate as soon as practicable. For example, in November 2020, the Board, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) issued an interagency statement stating that banking organizations generally should not enter into new contracts referencing USD LIBOR after December 31, 2021.12 The ARRC and other private industry groups also have worked to encourage an orderly transition away from USD LIBOR. For example, as discussed further below, the International Swaps and Derivatives Association (ISDA) has developed a contractual protocol by which parties to derivative transactions governed by ISDA documentation and other financial contracts can agree to incorporate more robust contractual fallback provisions that replace references to LIBOR with an alternative benchmark based on SOFR in the event that a given LIBOR rate ceases publication or is found by the FCA to no longer be representative.13 The ARRC has developed guiding principles for similar fallback language for cash products such as business loans, securitizations, floating rating notes, and consumer products, including specific recommended language for certain cash products.14 ISDA’s IBOR protocol and the ARRC fallback language recommendations were both subject to numerous public consultations, and they have received widespread adoption subsequent to their release.15
1 12 U.S.C. 5801(a)(1).
2 See, e.g., Financial Stability Oversight Council, 2013 Annual Report, 137-42.
3 See, e.g., U.S. Department of Justice (DOJ), Barclays Bank PLC Admits Misconduct Related to Submissions for London Interbank Offered Rate and the Euro Interbank Offered Rate and Agrees to Pay $160 Million Penalty (June 27, 2012), https://www.justice.gov/opa/pr/barclays-bank-plc-admits-misconduct-related-submissions-london-interbank-offered-rate-and; DOJ, Rabobank Admits Wrongdoing in Libor Investigation, Agrees to Pay $325 Million Criminal Penalty (October 29, 2013), https://www.justice.gov/opa/pr/rabobank-admits-wrongdoing-libor-investigation-agrees-pay-325-million-criminal-penalty; DOJ, Deutsche Bank’s London Subsidiary Agrees to Plead Guilty in Connection with Long-Running Manipulation of LIBOR (April 23, 2015), https://www.justice.gov/opa/pr/deutsche-banks-london-subsidiary-agrees-plead-guilty-connection-long-running-manipulation.
4 See ARRC, About, https://www.newyorkfed.org/arrc/about.
5 ARRC, The ARRC Selects a Broad Repo Rate as Its Preferred Alternative Reference Rate (June 22, 2017), https://www.newyorkfed.org/medialibrary/microsites/arrc/files/2017/ARRC-press-release-Jun-22-2017.pdf; ARRC, Second Report (March 2018): 17, https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2018/ARRC-Second-report.
6 SOFR is published daily by the Federal Reserve Bank of New York (FRBNY) in cooperation with the U.S. Department of the Treasury’s Office of Financial Research. See FRBNY, Secured Overnight Financing Rate Data, https://www.newyorkfed.org/markets/reference-rates/sofr. SOFR is calculated as a volume-weighted median of transaction-level tri-party repurchase agreement (repo) data collected from the Bank of New York Mellon, as well as general collateral financing repo transaction data and data on bilateral Treasury repo transactions cleared through the Fixed Income Clearing Corporation’s delivery-versus-payment service, which are obtained from the U.S. Department of the Treasury’s Office of Financial Research.
7 See Andrew Bailey, Chief Executive, FCA, “The Future of LIBOR” (speech at Bloomberg London, UK, July 27, 2017), https://www.fca.org.uk/news/speeches/the-future-of-libor.
8 See FCA, “FCA Announcement on Future Cessation and Loss of Representativeness of the LIBOR Benchmarks” (March 5, 2021), https://www.fca.org.uk/publication/documents/future-cessation-loss-representativeness-libor-benchmarks.pdf.
9 FCA, “FCA Announcement on Future Cessation.”
10 See FCA, “Further Consultation and Announcements on the Wind-down of LIBOR” (November 23, 2022), https://www.fca.org.uk/news/news-stories/further-consultation-announcements-wind-down-libor (discussing further consultation on synthetic LIBOR, https://www.fca.org.uk/publication/consultation/cp22-21.pdf).
11 See FCA, “Consultation on `Synthetic’ US Dollar LIBOR and Feedback to CP22/11” ¶ 1.7 (November 2022), https://www.fca.org.uk/publication/consultation/cp22-21.pdf; see also FCA, “FCA Announcement on Future Cessation.”
12 See Board, FDIC, OCC, “Statement on LIBOR Transition” (November 30, 2020), https://www.federalreserve.gov/supervisionreg/srletters/SR2027a1.pdf.
13 ISDA, ISDA 2020 IBOR Fallbacks Protocol, https://www.isda.org/protocol/isda-2020-ibor-fallbacks-protocol/.
14 See, e.g., ARRC, ARRC Guiding Principles for More Robust LIBOR Fallback Contract Language in Cash Products (July 9, 2018), https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2018/ARRC-principles-July2018; ARRC, Summary of ARRC’s LIBOR Fallback Language (November 15, 2019), https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2019/LIBOR_Fallback_Language_Summary; ARRC, ARRC Recommendations Regarding More Robust Fallback Language for New Issuance of LIBOR Securitizations (May 31, 2019), https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2019/Securitization_Fallback_Language.pdf; ARRC, ARRC Recommendations Regarding More Robust LIBOR Fallback Contract Language for New Closed-End, Residential Adjustable Rate Mortgages (November 15, 2019), https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2019/ARM_Fallback_Language.pdf.
15 See, e.g., ISDA, ISDA 20202 IBOR Fallbacks Protocol—List of Adhering Parties, https://www.isda.org/protocol/isda-2020-ibor-fallbacks-protocol/adhering-parties. The DOJ also reviewed ISDA’s IBOR protocol, concluded that it is unlikely to harm competition, and stated that the DOJ would not challenge ISDA’s IBOR protocol under federal antitrust laws. See DOJ, Justice Department Issues Favorable Business Review Letter to ISDA for Proposed Amendments to Address Interest Rate Benchmarks (October 1, 2020), https://www.justice.gov/opa/pr/justice-department-issues-favorable-business-review-letter-isda-proposed-amendments-address.
3-4265

Legacy Contracts and the Adjustable Interest Rate (LIBOR) Act

Notwithstanding governmental and private-sector efforts to encourage market participants to prepare for the cessation of USD LIBOR, there are a significant number of existing contracts that reference USD LIBOR. Of particular concern are so-called “tough legacy contracts,” which are contracts that reference USD LIBOR and will not mature by June 30, 2023, but which lack adequate fallback provisions providing for a clearly defined or practicable replacement benchmark following the cessation of USD LIBOR. To address these tough legacy contracts, multiple states adopted legislation, initially proposed by the ARRC, to provide a statutory remedy for financial contracts governed by the laws of the enacting states that reference USD LIBOR, will not mature until after USD LIBOR ceases or becomes nonrepresentative, and have no effective means to replace USD LIBOR after it ceases or becomes nonrepresentative.16 While these state laws provided a solution for a large number of tough legacy contracts, further legislative action was needed to address tough legacy contracts governed by the laws of other states.
Recognizing the need for a uniform, nationwide solution for replacing references to USD LIBOR in tough legacy contracts, on March 15, 2022, Congress enacted the Adjustable Interest Rate (LIBOR) Act (LIBOR Act) as part of the Consolidated Appropriations Act, 2022.17 Among other things, the LIBOR Act lays out a set of default rules that apply to tough legacy contracts subject to U.S. law.
The LIBOR Act broadly distinguishes between three categories of LIBOR contracts with different types of fallback provisions. For these purposes, the LIBOR Act defines “LIBOR contract” broadly to include any obligation or asset that, by its terms, uses the overnight, one-month, three-month, six-month, or 12-month tenors of USD LIBOR as a benchmark.18 Consistent with this definition, Regulation ZZ focuses on these stated tenors of USD LIBOR only. The LIBOR Act defines “fallback provisions” to mean the terms in a LIBOR contract for determining a benchmark replacement, including any terms relating to the date on which the benchmark replacement becomes effective.19
The first category of LIBOR contracts encompasses contracts that contain fallback provisions identifying a specific benchmark replacement that is not based in any way on any USD LIBOR values (except to account for the difference between LIBOR and the benchmark replacement) and that do not require any person (other than a benchmark administrator) to conduct a poll, survey, or inquiries for quotes or information concerning interbank lending or deposit rates.20 These LIBOR contracts generally can be expected to transition to the contractually agreed-upon benchmark replacement as provided by their fallback provisions on or before the LIBOR replacement date—the first London banking day after June 30, 2023 (unless the Board determines that any LIBOR tenor will cease to be published or cease to be representative on a different date).21
The second category of LIBOR contracts encompasses (i) contracts that contain no fallback provisions, as well as (ii) LIBOR contracts with fallback provisions that do not identify a determining person and that only (A) identify a benchmark replacement that is based in any way on USD LIBOR values (except to account for the difference between LIBOR and the benchmark replacement) or (B) require that a person (other than a benchmark administrator) conduct a poll, survey, or inquiries for quotes or information concerning interbank lending or deposit rates.22 For this second category of LIBOR contracts, the LIBOR Act provides that the benchmark replacement on the LIBOR replacement date will be the Board-selected benchmark replacement identified by the Board, which must be based on SOFR and include the tenor spread adjustments required under the LIBOR Act.23 Thus, any references to USD LIBOR in LIBOR contracts in this second category will, by operation of law, be replaced by the Board-selected benchmark replacement on the LIBOR replacement date.
For contracts that fall into this second category, the LIBOR Act provides a series of statutory protections, including that no person shall be subject to any claim or cause of action in law or equity or request for equitable relief, or have liability for damages, arising out of the use of the Board-selected benchmark replacement as a benchmark replacement.24 These statutory provisions are described in more detail below.
The third category of LIBOR contracts encompasses LIBOR contracts that contain fallback provisions authorizing a determining person to determine a benchmark replacement.25 The application of the LIBOR Act to LIBOR contracts in this third category depends on the determination, if any, made by the determining person. Where a determining person does not select a benchmark replacement by the LIBOR replacement date or the latest date for selecting a benchmark replacement according to the terms of the LIBOR contract (whichever is earlier), the LIBOR Act provides that the benchmark replacement for such LIBOR contract will be, by operation of law, the Board-selected benchmark replacement on and after the LIBOR replacement date.26 Where a determining person selects the Board-selected benchmark replacement as the benchmark replacement, the LIBOR Act provides that such selection shall be (i) irrevocable, (ii) made by the earlier of the LIBOR replacement date and the latest date for selecting a benchmark replacement according to the terms of the LIBOR contract, and (iii) used in any determinations of the benchmark under or with respect to the LIBOR contract occurring on and after the LIBOR replacement date.27
Although the LIBOR Act does not require a determining person to select the Board-selected benchmark replacement as the benchmark replacement for a LIBOR contract, the statute provides a series of statutory protections for any determining person who does so, including that a determining person generally shall not be subject to any claim or cause of action in law or equity or request for equitable relief, or have liability for damages, arising out of the selection of the Board-selected benchmark replacement as a benchmark replacement.28
Where the Board-selected benchmark replacement becomes the benchmark replacement for a LIBOR contract (either by operation of law or through the selection of a determining person), the LIBOR Act contemplates that certain conforming changes to a LIBOR contract may be necessary to facilitate the transition from USD LIBOR to the Board-selected benchmark replacement. These “benchmark replacement conforming changes” may arise in one of two ways. First, the LIBOR Act authorizes the Board to determine benchmark replacement conforming changes that, in its discretion, would address one or more issues affecting the implementation, administration, and calculation of the Board-selected benchmark replacement in LIBOR contracts.29 Second, for a LIBOR contract that is not a consumer loan, a calculating person may, in its reasonable judgment, determine that benchmark replacement conforming changes are otherwise necessary or appropriate to permit the implementation, administration, and calculation of the Board-selected benchmark replacement under or with respect to a LIBOR contract after giving due consideration to any benchmark replacement conforming changes determined by the Board.30 For this purpose, the LIBOR Act defines “calculating person” to mean, with respect to any LIBOR contract, any person, including the determining person, responsible for calculating or determining any valuation, payment, or other measurement based on a benchmark.31
The LIBOR Act provides that all benchmark replacement conforming changes (whether determined by the Board or, if applicable, a calculating person) shall become an integral part of the LIBOR contract, and a calculating person shall not be required to obtain consent from any other person prior to the adoption of benchmark replacement conforming changes.32 In addition, the determination, implementation, and performance of benchmark replacement conforming changes are generally subject to certain statutory protections provided by the LIBOR Act, which are designed to ensure continuity of contract.33 Finally, where a calculating person implements or (in the case of a LIBOR contract that is not a consumer loan) determines benchmark replacement conforming changes, the LIBOR Act provides that the calculating person shall not be subject to any claim or cause of action in law or equity or request for equitable relief, or have liability for damages.34
The LIBOR Act includes various other provisions beyond the main operative provisions and statutory protections described above. For example, the LIBOR Act generally provides that a bank may use any benchmark (including a benchmark that is not SOFR) in any non-IBOR loan made before, on, or after the date of enactment of the LIBOR Act that the bank determines to be appropriate, and that no federal supervisory agency may take enforcement or supervisory action against the bank solely because that benchmark is not SOFR.35 Other provisions of the LIBOR Act amend the Trust Indenture Act of 1939 (15 U.S.C. 77ppp(b)) and the Higher Education Act of 1965 (20 U.S.C. 1087-1(b)(2)(I)), respectively, to facilitate the transition from USD LIBOR.36 Finally, the LIBOR Act expressly preempts any provision of state or local law relating to the selection or use of a benchmark replacement or related conforming changes, or expressly limiting the manner of calculating interest (including the compounding of interest) as that provision applies to the selection or use of a Board-selected benchmark replacement or benchmark replacement conforming changes.37
16 See, e.g., N.Y. Gen. Oblig. Law art. 18-C; Ala. Code tit. 5, ch. 28; Fla. Stat. 687.15; Tenn. Code Ann. sec. 47-33-101 et seq.; Ind. Code 28-10-2; Neb. Rev. Stat. 8-3101 et seq.
17 Public Law 117-103, division U, codified at 12 U.S.C. 5801 et seq.
18 See 12 U.S.C. 5802(16) (definition of “LIBOR contract”), 5802(15) (definition of “LIBOR”). The LIBOR Act does not apply to contracts that use the one-week or two-month tenors of USD LIBOR as a benchmark. The LIBOR Act defines “benchmark” to mean an index of interest rates or dividend rates that is used, in whole or in part, as the basis of or as a reference for calculating or determining any valuation, payment, or other measurement. 12 U.S.C. 5802(1).
19 12 U.S.C. 5802(11). The LIBOR Act defines “benchmark replacement” to mean a benchmark, or an interest rate or dividend rate (which may or may not be based in whole or in part on a prior setting of LIBOR), to replace LIBOR or any interest rate or dividend rate based on LIBOR, whether on a temporary, permanent, or indefinite basis, under or with respect to a LIBOR contract. 12 U.S.C. 5802(3).
20 See 12 U.S.C. 5803(b). The LIBOR Act defines “benchmark administrator” to mean a person that publishes a benchmark for use by third parties. 12 U.S.C. 5802(2).
21 12 U.S.C. 5803(f)(2); see also 12 U.S.C. 5802(17) (definition of “LIBOR replacement date”). The Board has not determined, and does not expect to determine, a LIBOR replacement date earlier than the first London banking day after June 30, 2023.
22 The LIBOR Act deems these types of fallback provisions to be null and void by operation of law. 12 U.S.C. 5803(b). To the extent a LIBOR contract contains fallback provisions that would be applied ahead of another, separate benchmark replacement, then under the LIBOR Act, these fallback provisions would be disregarded and the separate benchmark replacement would apply.
23 12 U.S.C. 5803(a)-(b); see also 12 U.S.C. 5802(6) (definition of “Board-selected benchmark replacement”).
24 12 U.S.C. 5804(a)-(b), (c)(1), (d).
25 The LIBOR Act defines “determining person” to mean, with respect to any LIBOR contract, any person with the authority, right, or obligation, including on a temporary basis (as identified by the LIBOR contract or by the governing law of the LIBOR contract, as appropriate) to determine a benchmark replacement. 12 U.S.C. 5802(10).
26 12 U.S.C. 5803(c)(3).
27 12 U.S.C. 5803(c)(2).
28 12 U.S.C. 5804(c)(1)-(2), 5804(a)-(d). This statutory safe harbor also applies to the use of the Board-selected benchmark replacement other than at the selection of a determining person.
29 12 U.S.C. 5802(4)(A).
30 12 U.S.C. 5802(4)(B). The LIBOR Act defines “consumer loan” to mean a consumer credit transaction, which is defined by cross-reference to the Truth in Lending Act. 12 U.S.C. 5802(9) (definition of “consumer loan”); 12 U.S.C. 5802(8) (definitions of “consumer” and “credit”).
31 12 U.S.C. 5802(7).
32 12 U.S.C. 5803(d).
33 See 12 U.S.C. 5804(a)-(d).
34 12 U.S.C. 5804(c).
35 12 U.S.C. 5805.
36 LIBOR Act sections 108-09, codified at 15 U.S.C. 77ppp(b) and 20 U.S.C. 1087-1(b)(2)(I).
37 12 U.S.C. 5806.
3-4265

Overview

Regulation ZZ, as required by the LIBOR Act, identifies SOFR-based Board-selected benchmark replacements for LIBOR contracts that will not mature prior to the LIBOR replacement date and do not contain clear and practicable benchmark replacements. Regulation ZZ identifies different SOFR-based Board-selected benchmark replacements for different categories of LIBOR contracts. In addition, Regulation ZZ identifies certain benchmark replacement conforming changes related to the implementation, administration, and calculation of the Board-selected benchmark replacement. Consistent with the LIBOR Act, Regulation ZZ also expressly indicates that a determining person may select the Board-selected benchmark replacement for the relevant type of LIBOR contract, with any applicable benchmark replacement conforming changes. In addition, Regulation ZZ expressly provides that the LIBOR Act’s protections related to the selection or use of the Board-selected benchmark replacement shall apply to any LIBOR contract for which the Board-selected benchmark replacement becomes the benchmark replacement (whether by operation of law or by the selection of a determining person). Finally, Regulation ZZ indicates that, under the LIBOR Act, the Board’s Regulation ZZ (12 CFR part 253) preempts any state or local law or standard relating to the selection or use of a benchmark replacement or conforming changes.
Section 253.1 sets forth the authority for, purpose of, and scope of Regulation ZZ. Significantly, and consistent with the statute as described above, Regulation ZZ does not apply to (i) contracts that do not reference the overnight or one-, three-, six-, or 12-month tenors of LIBOR or (ii) LIBOR contracts that have fallback provisions providing for the use of a clearly defined and practicable replacement benchmark for LIBOR (including LIBOR contracts where the determining person selects a benchmark replacement other than the Board-selected benchmark replacement), except as provided in section 253.3(a)(1)(iii) and (c).38 Section 253.1 also clarifies that any determining person’s selection of the applicable Board-selected benchmark replacement is subject to sections 253.4 (identifying Board-selected benchmark replacements for specific categories of LIBOR contracts), 253.5 (concerning benchmark replacement conforming changes), 253.6 (concerning preemption), and 253.7 (concerning statutory protections for the selection or use of the Board-selected benchmark replacement). Regulation ZZ also applies only to existing contracts governed by federal law or the law of any state. In addition, consistent with the LIBOR Act, section 253.1 states that the parties to a LIBOR contract may, by written agreement, specify that a LIBOR contract shall not be subject to the rule.39
Section 253.2 provides definitions for many of the terms used in Regulation ZZ. Most of the defined terms in section 253.2 are substantially the same as the defined terms in the LIBOR Act. However, section 253.2 includes additional definitions for the terms “30-day Average SOFR,” “90-day Average SOFR,” “CME Term SOFR,” “derivative transaction,” “derivative transaction fallback observation day,” “Federal Housing Finance Agency (FHFA)-regulated entity,” “Federal Family Education Loan Program (FFELP) Asset-Backed Securitization (ABS),” “FHFA-regulated-entity contract,” “ISDA protocol,” and “relevant benchmark administrator.” For ease of reference, the ISDA protocol in its entirety is republished in appendix A.
Section 253.3 addresses the applicability of the regulation to LIBOR contracts. Specifically, for the following LIBOR contracts, the applicable Board-selected benchmark replacement indicated in section 253.4 shall be the benchmark replacement for the contract on and after the LIBOR replacement date unless an express exception applies: (i) LIBOR contracts that contain no fallback provisions; (ii) LIBOR contracts that contain fallback provisions that identify neither a specific benchmark replacement nor a determining person; and (iii) LIBOR contracts that contain fallback provisions that identify a determining person, but where the determining person has not selected a benchmark replacement by the earlier of the LIBOR replacement date and the latest date for selecting a benchmark replacement according to the terms of the LIBOR contract, for any reason.40
In evaluating whether a LIBOR contract has any of these characteristics on the LIBOR replacement date, Regulation ZZ mirrors the statute and disregards any reference in any fallback provisions of a LIBOR contract to the following: (i) a benchmark replacement that is based in any way on any LIBOR value, except to account for the difference between LIBOR and the benchmark replacement; or (ii) a requirement that a person (other than a benchmark administrator) conduct a poll, survey, or inquiries for quotes or information concerning interbank lending or deposit rates (collectively, “LIBOR- or poll-based fallback provisions”).41 For example, if a LIBOR contract specifies the last published LIBOR value will be used if LIBOR is not published, but contains no other fallback provisions, then, pursuant to section 253.3(a)(2), this language would be disregarded as of the LIBOR replacement date. As a result, on the LIBOR replacement date, the LIBOR contract would be treated as having no fallback provisions and would transition to the Board-selected benchmark replacement under Regulation ZZ.
Consistent with the LIBOR Act, section 253.3(b) lists three types of contracts that generally would not be subject to the act: (i) any LIBOR contract that the parties have agreed in writing shall not be subject to the act; (ii) any LIBOR contract that contains fallback provisions that identify a benchmark replacement that is not based in any way on any LIBOR value (including the prime rate or the effective federal funds rate), after disregarding any LIBOR- or poll-based fallback provisions; and (iii) any LIBOR contract as to which a determining person does not elect to use the Board-selected benchmark replacement, again after disregarding any LIBOR- or poll-based fallback provisions.42 Importantly, however, even if a determining person does not elect to use the Board-selected benchmark replacement, the LIBOR contract will transition to the Board-selected benchmark replacement by operation of law if the determining person does not select any benchmark replacement by the earlier of (i) the LIBOR replacement date and (ii) the latest date for selecting a benchmark replacement according to the terms of the LIBOR contract.43
Section 253.4 identifies the Board-selected benchmark replacements for various types of contracts subject to the LIBOR Act. The Board agrees with the ARRC’s observation that different benchmark replacements may be appropriate for derivative transactions and other transactions (hereafter, “cash transactions”).44 Therefore, Regulation ZZ identifies different benchmark replacements for derivative transactions and for different types of cash transactions. Consistent with the LIBOR Act, all of the Board-selected benchmark replacements (i) are based upon SOFR and (ii) incorporate spread adjustments for each specified tenor of LIBOR.45
The spread adjustments specified in the LIBOR Act are intended to address certain differences between SOFR and LIBOR, including the fact that LIBOR is unsecured and therefore includes an element of bank credit risk which may cause it to be higher than SOFR.46 LIBOR also may include term premia and reflect supply and demand conditions in wholesale unsecured funding markets, each of which may cause LIBOR to be higher than SOFR.47 The LIBOR Act prescribes static spread adjustments based on the tenor of LIBOR referenced in the contract (tenor spread adjustments)—specifically, 0.644 basis points (bps) (0.00644 percent) for overnight LIBOR, 11.448 bps (0.11448 percent) for one-month LIBOR, 26.161 bps (0.26161 percent) for three-month LIBOR, 42.826 bps (0.42826 percent) for six-month LIBOR, and 71.513 bps (0.71513 percent) for 12-month LIBOR.48 For clarity, Regulation ZZ reiterates these tenor spread adjustments in paragraph (c) of section 253.4.49
Section 253.5 includes provisions mirroring the language in sections 103(4) and 104(d) of the LIBOR Act, including the Board’s ability to, in its discretion, publish aditional bench-mark replacement conforming changes, by regulation or order, and a calculating person’s ability to make certain conforming changes with respect to a LIBOR contract that is not a consumer loan, consistent with the LIBOR Act.50 Regulation ZZ also specifies certain conforming changes and, consistent with the LIBOR Act, indicates that these conforming changes shall become an integral part of any LIBOR contract for which the Board-selected benchmark replacement replaces the contract’s references to LIBOR.51
Section 253.6 establishes that Regulation ZZ preempts any provision of state or local law, statute, rule, regulation, or standard relating to the selection or use of a benchmark replacement or related conforming changes, as provided in section 107 of the LIBOR Act.
Section 253.7 expressly states that the provisions of section 105(a)-(d) of the LIBOR Act shall apply to any LIBOR contract for which the Board-selected benchmark replacement becomes the benchmark replacement pursuant to section 253.3(a) or (c).52 The section separately states that nothing in Regulation ZZ is intended to alter or modify the availability or effect of the provisions of section 105(e) of the LIBOR Act.53
38 12 U.S.C. 5803(f)(2)-(3). However, consistent with the LIBOR Act, Regulation ZZ applies to LIBOR contracts that identify a determining person if the determining person has not selected a benchmark replacement by the earlier of (i) the LIBOR replacement date and (ii) the latest date for selecting a benchmark replacement according to the terms of the contract. See section 253.3(a)(1)(iii). In addition, Regulation ZZ mirrors provisions in the LIBOR Act related to any selection by a determining person of the Board-selected benchmark replacement. See section 253.3(c).
39 See 12 U.S.C. 5803(f)(1).
40 12 CFR 253.3(a).
41 12 CFR 253.3(a)(2). Under the statute, any such references in any fallback provisions of the LIBOR contract would be disregarded as if not included in the fallback provisions of the contract and would be deemed null and void and without any force or effect. 12 U.S.C. 5803(b).
42 12 CFR 253.3(b). Nothing in Regulation ZZ is intended to alter or modify the availability or effect of the provisions of section 105(e) of the LIBOR Act, and those provisions may apply to these LIBOR contracts. See 12 U.S.C. 5804(e).
43 12 CFR 253.3(a)(1)(iii).
44 ARRC, ARRC Best Practice Recommendations Related to Scope of Use of the Term Rate (May 4, 2022), https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2021/ARRC_Scope_of_Use.pdf.
45 See 12 CFR 253.4. See also 12 U.S.C. 5802-03.
46 ARRC, ARRC Consultation on Spread Adjustment Methodologies for Fallbacks in Cash Products Referencing USD LIBOR (January 21, 2020), https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC_Spread_Adjustment_Consultation.pdf.
47 ARRC, ARRC Consultation on Spread Adjustment Methodologies.
48 See 12 U.S.C. 5802(20) (defining “tenor spread adjustment”). These spread adjustments were based on a methodology originally advanced by ISDA that uses the historical median over a five-year lookback period calculating the difference between USD LIBOR and SOFR. ARRC, ARRC Announces Further Details Regarding Its Recommendation of Spread Adjustments for Cash Products (June 30, 2020), https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC_Recommendation_Spread_Adjustments_Cash_Products_Press_Release.pdf.
49 12 CFR 253.4(c).
50 12 CFR 253.5(a).
51 12 CFR 253.5(a) and (b).
52 12 CFR 253.7(a).
53 12 CFR 253.7(b).
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