On December 16, 2022, the Board of Governors of the Federal Reserve System (the "Board") adopted final rule 12 C.F.R. Part 253, "Regulation Implementing the Adjustable Interest Rate (LIBOR) Act (Regulation ZZ)" ("Rule 253" or the "Final Rule").1 Rule 253 identifies SOFR-based benchmark rates that will replace US dollar LIBOR in certain financial contracts after June 30, 2023. Rule 253 will become effective 30 days after its publication in the Federal Register.
On March 5, 2021, the UK Financial Conduct Authority (the "FCA"), which regulates the administrator of the London Interbank Offered Rate ("LIBOR"), announced that all remaining tenors of US dollar ("USD") LIBOR will cease to be published immediately after June 30, 2023.2 To address the permanent cessation of USD LIBOR, Congress enacted the Adjustable Interest Rate (LIBOR) Act ("AIRLA") on March 15, 2022, to provide a federal solution for replacing references to USD LIBOR in existing contracts that either lack, or contain insufficient, LIBOR fallback provisions.3 AIRLA required the Board to issue implementing regulations that would apply to financial contracts that: are governed by US law; will not mature before June 30, 2023; use or contain references to overnight, one-month, three-month, six-month or 12-month USD LIBOR tenors; and have terms which do not provide for the use of a clearly defined or practicable benchmark rate to replace USD LIBOR when it ceases to be published.
In July 2022, the Board proposed regulations and identified five Board-selected benchmark replacement rates based on the secured overnight financing rate ("SOFR") that would replace USD LIBOR in different categories of USD LIBOR contracts: derivative transactions, contracts where a government-sponsored enterprise is a party, and all other affected contracts that use or reference USD LIBOR.4 The Final Rule adopted last Friday is substantially similar to the Board's July proposal, with certain changes made in response to comments received from the public.
Rule 253 responds to several rulemaking requirements of AIRLA, and resolves some of the remaining questions about how outstanding USD LIBOR contracts will transition to a replacement rate after USD LIBOR ceases publication on the first London banking day after June 30, 2023 (the "LIBOR replacement date"). In addition to adding some new defined terms not used in AIRLA, Rule 253 does the following:
- 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;
- identifies certain benchmark replacement conforming changes related to the implementation, administration, and calculation of the Board-selected benchmark replacement;
- 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;
- expressly provides that the AIRLA'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); and
- clarifies that, under AIRLA, Rule 253 pre-empts any state or local law or standard relating to the selection or use of a benchmark replacement or conforming changes.
Rule 253 updates some definitions in AIRLA and adds some new ones.
The bold and italicized words below in the definition of "determining person" in Rule 253.2 were added by the rule:
"Determining person means, with respect to any LIBOR contract, any person with the sole 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, whether or not the person's authority, right, or obligation is subject to any contingencies specified in the LIBOR contract or by the governing law of the LIBOR contract." (Emphasis added)
The larger change was made in response to concerns that, if the determining person's authority to determine a benchmark replacement did not spring into existence until on or after the LIBOR replacement date, the determining person's actions might be taken too late to be effective. Under the Final Rule, a "determining person" includes a person with the right to select a benchmark replacement rate even if that right would vest only in the future or is subject to some contingency. For instance, if a LIBOR contract authorizes a person to select a benchmark replacement only when LIBOR becomes unavailable or non-representative (e.g., after June 30, 2023), that person, despite not having the current authority to select the LIBOR replacement rate now, will still qualify as a determining person that would be able to select the Board-selected LIBOR replacement rate even before the LIBOR replacement date. Thus, the person need not wait until the LIBOR replacement date to exercise its authority. The Board also clarified that a determining person selecting a Board-selected benchmark replacement pursuant to the authority and statutory protections of AIRLA must choose the Board-selected benchmark replacement prescribed by the Board for that contract type, as identified in Rule 253.4.5
The "relevant benchmark administrator" for CME Term SOFR is defined as CME Group Benchmark Administration, Ltd. ("CME Group").
Consistent with AIRLA and the proposed version of Rule 253, the following LIBOR contracts (such as USD LIBOR floating rate notes6 ) are subject to Rule 253:
- LIBOR contracts that contain no fallback provisions;
- LIBOR contracts that contain fallback provisions that identify neither a specific benchmark replacement nor a determining person; and
- 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
- If a determining person does not elect to use any benchmark replacement, the LIBOR contract will transition to the Board-selected benchmark replacement by operation of law.8
For legacy USD LIBOR floating rate notes with fallbacks based on the 2006 ISDA Definitions, AIRLA and Rule 253 will, by operation of law and on the LIBOR replacement date, disregard the fallback provisions and nullify the polling requirements9 stated in the terms of the notes, and replace USD LIBOR with the Board-selected benchmark replacement (CME Term SOFR of the same tenor) and the relevant spread adjustment.
These LIBOR contracts are not subject to AIRLA:
- any LIBOR contract that the parties have agreed in writing shall not be subject to AIRLA;
- 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
- any LIBOR contract as to which a determining person selects a benchmark replacement other than the Board-selected benchmark replacement, again after disregarding any LIBOR- or poll-based fallback provisions.10
The Final Rule also eliminated the use of the terms "covered contract" and "non-covered contract" originally found in the Proposing Rule, based on feedback from commenters who thought these terms did not fully align with AIRLA's language and were confusing.
With respect to the determination of a determining person, the Board chose not to impose any notice requirements (e.g., requiring a determining person to provide notice to one or more parties) concerning the determining person's selection.11
Rule 253.3(d) is a new section not included in the proposed rule, which provides that LIBOR contracts that transition to the Board-selected benchmark replacement generally will not have their other provisions impaired by the rule. Contractual provisions that are specifically preserved include the date for determining a benchmark (subject to certain exceptions), rounding conventions, provisions referencing LIBOR or any LIBOR value prior to the LIBOR replacement date (including any provision requiring a person to look back to a LIBOR value as of a date preceding the LIBOR replacement date) and provisions applying any cap, floor, modifier or spread adjustment to which LIBOR had been subject pursuant to the terms of a LIBOR contract.
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1. See the Board's adopting release for Rule 253 (the "Adopting Release").
2. See "FCA announcement on future cessation and loss of representativeness of the LIBOR benchmarks" (March 5, 2021).
3. Pub. L. 117-103, div. U, codified at 12 U.S.C. 5801 et seq. AIRLA was included in the Consolidated Appropriations Act, 2022. See Division U at pages 777-786.
4. See the Board's proposing release (the "Proposing Release").
5. See the Adopting Release, supra note 1, at 19.
6. AIRLA and Rule 253 have a much broader scope than just USD LIBOR floating rate notes, as AIRLA and Rule 253 affect all "LIBOR contracts," as defined therein. This alert provides a general discussion of AIRLA and Rule 253 applicable to LIBOR contracts, but highlights certain issues relevant to USD LIBOR floating rate notes.
7. Rule 253.3(a). Floating rate notes with a "determining person" provision generally were issued prior to the Alternative Reference Rates Committee's ("ARRC") publication of recommended USD LIBOR fallback provisions in April 2019.
8. Rule 253.3(a)(1)(iii); Section 103(c)(3) of AIRLA.
9. Generally, these are requirements for a person (other than a benchmark administrator) to conduct a poll, survey or inquiries for quotes or information concerning interbank lending or deposit rates.
10. Rule 253.3(b); Section 104(f)(3) of AIRLA.
11. See the Adopting Release, supra note 1, at 23.
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