On December 7, 2021, the US Consumer Financial Protection Bureau (“CFPB” or “Bureau”) issued a final rule to facilitate the transition away from using the London Interbank Offered Rate (LIBOR). The final rule amends Regulation Z, which implements the Truth in Lending Act (TILA). The rule will take effect on April 1, 2022, and compliance will become mandatory on October 1, 2022. This Legal Update addresses some of the ways the final rule will affect existing and future loans.
Financial institutions in the United States have used LIBOR as a common benchmark rate for various adjustable-rate loan products. However, in 2017, the UK Financial Conduct Authority announced it would sunset LIBOR after December 31, 2021. On December 4, 2020, ICE Benchmark Administration Limited (IBA), the current administrator of LIBOR, published a consultation on its intention to cease the publication of the one-week and two-month USD LIBOR settings immediately following the LIBOR publication on December 31, 2021, and the remaining USD LIBOR settings, including overnight, one-, three-, and six-month, and one-year LIBOR, immediately following the LIBOR publication on June 30, 2023.
As we discussed in our July 20, 2020, Legal Update (“Part II”), on June 4, 2020, the CFPB announced that it was taking several steps to facilitate the LIBOR transition. These steps included updates to the Consumer Handbook on Adjustable Rate Mortgages (the “CHARM booklet”), a notice of proposed rulemaking suggesting a number of clarifying amendments to the Truth-in-Lending Act’s Regulation Z, and the issuance of FAQs on other LIBOR transition topics. Now, after a period of notice and comment, the CFPB has published its final rule amending provisions of Regulation Z.
II. Final Rule
The final rule sets forth a roadmap for Home Equity Line of Credit (HELOC) creditors and card issuers to choose a compliant index to replace LIBOR. Under the final rule, HELOC creditors and card issuers can transition away from using LIBOR to a replacement index on or after April 1, 2022, which is before the commonly used LIBOR tenors are expected to become unavailable. The Bureau adopted several amendments regarding open-end credit and closed-end credit provisions in Regulation Z to help navigate the anticipated sunset of LIBOR. This Legal Update summarizes some of the key provisions in the final rule.
A. OPEN-END CREDIT
What is a “substantially similar” replacement index?
For open-end credit, the final rule requires HELOC creditors and card issuers to calculate the APR using a replacement index that is “substantially similar” to the rate calculated using LIBOR.1 The replacement index can either be a newly established index with no history or an established index, but it must have historical fluctuations substantially similar to those of LIBOR.
The final rule provides examples of the types of factors the CFPB will consider in determining whether a replacement index meets the “historical fluctuations are substantially similar” standard. It states that the relevant factors will “depend on the replacement index being considered and the LIBOR index being replaced.”2 These factors include, but are not limited to, whether:
(1) The movements over time are substantially similar; and
(2) Consumers’ payments using the replacement index compared to payments using the LIBOR index are substantially similar if there is sufficient historical data for this analysis.
The CFPB also created safe harbors for indices such as the prime rate published in the Wall Street Journal (“Prime”) and the spread-adjusted indices based on SOFR (“SOFR-based indices”) recommended by the Alternative Reference Rates Committee (“ARRC”). The CFPB determined that Prime and the SOFR-based indices have historical fluctuations similar to those of the LIBOR indices.3 It declined to provide safe harbors with respect to the AMERIBOR®, the EFFR, or the CMT rates.4
What happens when LIBOR becomes “unavailable”?
The final rule makes clarifying changes to existing Regulation Z provisions on the replacement of an index when LIBOR becomes unavailable. A creditor generally must use the value of the replacement index and the LIBOR index on the day that the LIBOR index becomes unavailable.5
Additionally, the final rule provides that if the replacement index is not published on the day that the LIBOR index becomes unavailable, the creditor generally must use the previous calendar day that both indices were published in determining whether the APR based on the replacement index is substantially similar to the rate based on the LIBOR index.
The one exception is when creditors use the SOFR-based spread-adjusted index recommended by the ARRC for consumer products to replace the one-month, three-month, six-month, or one-year USD LIBOR index. For the LIBOR index value, the creditor must use the index value on June 30, 2023, and for the SOFR-based spread-adjusted index value, the creditor must use the index value on the first date that the SOFR-based index is published.
It is important to note that the CFPB declined to adopt specific guidance to assist creditors in determining whether LIBOR is “unavailable” for purposes of Regulation Z.6 Instead of providing the date that LIBOR officially will be unavailable, the CFPB explained that these new rules regarding unavailability will guide the transition.
What kind of “change-in-terms notices” must be provided?
The final rule requires HELOCs and credit card accounts to notify consumers about how variable rates will be determined after the LIBOR transition.
For HELOCs, the “change-in-terms notices” must disclose (1) the index that is replacing the LIBOR index and (2) any adjusted margin used to calculate the consumer’s rate.7 For plans other than HELOCs, the creditor must disclose the following information in a tabular format: (1) the amount of the new rate (as calculated using the new index) and (2) indicate that the rate varies and how the rate is determined.8 For HELOCs and non-HELOC plans, a creditor also is required to disclose in the change-in-terms notice any increased periodic rate or APR calculated using the replacement index at the time the change-in-terms notice is provided.
In both cases, a change in the index used in making rate adjustments is something that must be disclosed regardless of whether the change in the index value or margin involves a reduction in a finance or other charge. However, if the change does not result from an index change, Regulation Z carves out an exception that states that a change-in-terms notice is not required if the change involves a reduction in the finance or other charge.
The final rule also details how creditors may disclose information about the periodic rate and APR in a change-in-terms notice when the creditor is replacing a LIBOR index with an unpublished SOFR-based spread-adjusted index. Because LIBOR is anticipated to sunset after Friday, June 30, 2023, and the SOFR-based spread-adjusted indices will not be published until July 3, 2023, creditors may not know what index to use during this gap period. To address this issue, the final rule states that if any information necessary for accurate disclosure is unknown to the creditor, it must make a disclosure based on the best information reasonably available and clearly state that the disclosure is an estimate.
Are there exceptions to the rate reevaluation provisions?
Generally, when a card issuer increases a rate on a credit card account, the issuer must complete an analysis reevaluating the rate increase every six months until the rate is reduced by a certain degree. However, the final rule added an exception to the rate reevaluation provisions.9 It provides an exception from these requirements if the rate increase on a credit card account occurs due to replacing a LIBOR index according to the specifications in the final rule or as a result of the LIBOR index becoming unavailable. This exception does not apply to rate increases already subject to rate reevaluation provisions prior to the transition from the use of a LIBOR index. Thus, the final rule releases card issuers from the burden of completing an analysis every six months if the rate increase is not already subject to rate reevaluation provisions and the change is due to the discontinuation of LIBOR.
B. CLOSED-END CREDIT
What is a “comparable index”?
Under Regulation Z, if a creditor changes the index of a variable-rate closed-end loan to an index that is not a comparable index, the index change may constitute a refinancing for purposes of Regulation Z, triggering certain requirements. To ensure a smooth transition away from LIBOR, the final rule details how to determine whether a replacement index is a comparable index to a particular LIBOR index for purposes of the closed-end refinancing provisions.10
With respect to closed-end credit, the rule identifies SOFR-based spread-adjusted indices as an example of a “comparable index” for the LIBOR indices that they are intended to replace.11 This final rule does not set forth safe harbors with respect to Prime, AMERIBOR®, EFFR, or the CMT rates.
The final rule provides examples of the types of factors the CFPB will consider in determining whether the replacement index meets the “comparable” standard for closed-end transactions. These factors include, but are not limited to, whether:12
(1) The movements over time are comparable;
(2) The consumers’ payments using the replacement index compared to payments using the LIBOR index are comparable if there is sufficient data for this analysis;
(3) The index levels are comparable;
(4) The replacement index is publicly available; and
(5) The replacement index is outside the control of the creditor.
However, the CFPB acknowledged that it is not establishing a principles-based standard for determining whether a replacement index is comparable to a particular LIBOR index for closed-end credit. Whether a replacement index is a “comparable index” will still be a fact-specific determination that depends on the replacement index being considered, the LIBOR tenor being replaced, and the prevailing market conditions. Thus, the five factors will simply be a non-exhaustive list that the CFPB will consider when determining whether a replacement index is a comparable index.
The final rule’s amendments to Regulation Z provide important guidance that originators, holders, and servicers can use to prepare for the LIBOR transition. However, many questions remain. The CFPB acknowledged that the final rule does not include references to the one-year USD LIBOR index13 or provisions about what date LIBOR officially will be considered unavailable under Regulation Z. Additionally, despite the CFPB’s attempts to clarify what qualifies as a “substantially similar” or a “comparable” index, creditors likely will continue to be uncertain about whether various replacement indices satisfy the final rule’s standards. It remains to be seen how entities will adjust to the imminent discontinuation of LIBOR.