Financial Regulators Clarify Key LIBOR Transition Considerations But Some Questions Remain

On 20 October 2021, in a Joint Statement on Managing the LIBOR Transition, the Board of Governors of the Federal Reserve System, Consumer Financial Protection Bureau (“CFPB”), Federal Deposit Insurance Corporation, National Credit Union Administration, Office of the Comptroller of the Currency, and State Bank and Credit Union Regulators (the “Regulators”) emphasized their expectations that supervised institutions will transition away from LIBOR in an orderly fashion by the end of 2021. Transition preparedness will be an increasing area of supervisory focus and review.

The Regulators summarized prior guidance,[1] then clarified a number of key supervisory considerations, including the following:

1. Entering new financial contracts, including derivatives, that use LIBOR as a reference rate after 31 December 2021 would create safety and soundness risks. Importantly, for this purpose, “new contract” would include an agreement that: (a) creates additional LIBOR exposure for a supervised institution (with limited defined exceptions); or (b) extends the term of an existing LIBOR contract. A draw on an existing enforceable agreement would not be viewed as a new contract. However, other types of contract changes are not so clearly delineated. For example, if an amendment increases the contractual spread (either directly or by the operation of a specified financial matrix), does this create “additional LIBOR exposure” and, as a result, constitute a “new contract”? Similarly, other amendments to existing contracts might be deemed by an applicable regulator to constitute such “additional LIBOR exposure” and be a “new contract” for purposes of LIBOR transition.
2. Contracts executed on or before 31 December 2021 should use a reference rate other than LIBOR or incorporate LIBOR fallback language that refers to a strong and clearly defined alternative reference rate.
3. Supervised institutions should ensure that alternative rate selections are appropriate for their “products, risk profile, risk management capabilities, customer and funding needs, and operational capabilities,” and understand “any fragilities associated with that rate and the markets that underlie it.”
4. Supervised institutions should identify all LIBOR-referencing contracts that mature after the relevant tenor ceases and fail to include adequate fallback language.
5. All new and updated financial contracts should include fallback language that refers to a strong and clearly defined alternative reference rate in the event that the initial reference rate is discontinued.
6. Supervised institutions are encouraged to communicate their transition plans to appropriate parties, including customers, clients, and counterparties, and should ensure that systems and operational capabilities are in place and ready for transition.

In a separate related press release, CFPB noted that it is working on finalizing its 4 June 2020 Notice of Proposed Rulemaking and FAQs relating to the LIBOR transition, which addresses compliance with existing CFPB regulations for consumer financial products and services. CFPB expects to issue the final rule in January 2022.

LIBOR Transition Litigation Risks

As the transition away from LIBOR quickly approaches, supervised institutions face numerous challenges, not least of which is exposure to litigation risk.  To date, the LIBOR transition issue has prompted at least one putative class action, alleging that a mortgage servicer prematurely switched from LIBOR to another index with a higher interest rate. [2]  The proposed class representative alleged that this switch violated the mortgage contract because LIBOR remains available and, as a result, the switch was not yet necessary. He further contended that this change therefore resulted in higher monthly interest charges than were warranted under the contract.  On behalf of a putative class of California mortgagors, the complaint alleged claims of breach of contract, conversion, alleged violation of California’s Rosenthal Fair Debt Collection Practices Act, alleged violation of California’s Unfair Competition Law, and alleged violation of California’s Consumer Legal Remedies Act.

While most LIBOR transition-related disputes likely are not ripe yet, supervised institutions should expect that consumers and their counsel will closely monitor future Regulators’ statements and the CFPB’s expected final rule for any hook to use in future consumer and class action lawsuits.  Clear and proactive customer communication concerning transition plans will be important to minimize any consumer protection-type claims. Supervised institutions should consult with advisors as appropriate.

With fewer than 75 days until 31 December, we will be keeping a close eye on market trends in these areas.

[1] Joint Statement on Managing the LIBOR Transition (Federal Financial Institutions Examination Council, 1 July 2020); Statement on Reference Rates for Loans (Board of Governors of the Federal Reserve System/Federal Deposit Insurance Corporation/Office of the Comptroller of the Currency, 6 November 2020); Statement on LIBOR Transition (Board of Governors of the Federal Reserve System/Federal Deposit Insurance Corporation/Office of the Comptroller of the Currency, 30 November 2020); Letter to Credit Unions 21-CU-03 re LIBOR Transition (National Credit Union Administration, 17 May 2021); and Supervisory Letter SL No. 21-01 re Evaluating LIBOR Transition Plans (National Credit Union Administration, 17 May 2021).

[2]  Michael Friedman v. PHH Mortgage Corp., 2:21-cv-02234-MWF-AS (C.D. Cal.).

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