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On December 7, 2021, the Consumer Financial Protection Bureau (“CFPB”) published its final rule (“Rule”) facilitating the transition away from LIBOR for open-end and closed-end consumer financial products. The Rule amends provisions of Regulation Z, which implements the Truth in Lending Act to allow for the transition from U.S. dollar LIBOR to the Secured Overnight Financing Rate (“SOFR”) and other alternative reference rates. SOFR is deemed compliant as a replacement index whereas other alternative reference rates must pass the “comparability” or “substantially similar” analyses discussed below.

This rule takes place with the backdrop that certain U.S. dollar LIBOR tenors ceased publication on December 31, 2021 and the remaining tenors will no longer be published after June 2023. The cessation of LIBOR has rightfully received more attention for its impact on commercial credit products because of its omnipresence in that market, but this transition will also have a significant effect on consumer credit products.

Closed-End Credit and the “Comparability” Analysis

At a high level, for closed-end credit products, the Rule (1) provides details on how to determine whether a replacement rate qualifies as a comparable index; and (2) makes a number of technical edits, which among other things, replace LIBOR references with references to SOFR.

The Rule discusses example indices that are considered comparable to certain LIBOR indices – and as such, would not trigger a refinance of the transaction under the existing Regulation Z provisions. It identifies SOFR-based spread-adjusted indices recommended by the Alternative Reference Rates Committee (“ARRC”) for these consumer products to replace the one, three, or six-month USD LIBOR. The Rule does not reach a similar conclusion for the 12-month spread-adjusted SOFR. The ARRC plans to announce which SOFR-based spread-adjustment replacement index it will recommend to replace the one-year USD LIBOR index in June 2022.

Further, the Rule includes a non-exhaustive list of factors creditors should consider when determining whether a replacement index is comparable to the LIBOR tenor it replaces, as required by Regulation Z. These factors include, but are not limited to, whether: (1) the replacement index is publicly available; (2) the movement of the index levels of the two indices over time are comparable; and (3) the replacement index is outside the control of the creditor.

Open-End Credit and the “Substantially Similar” Analysis

At a high level, for closed-end credit products, the Rule provides details on how to determine whether a replacement rate has historical fluctuations that are substantially similar to LIBOR.

The Rule:

• Permits HELOC creditors and card issues to transition away from LIBOR in April of 2022, well before LIBOR ceases publication so long as the replacement rate meets certain qualifications;[1]
• Makes clarifying changes for the replacement of an index when it becomes unavailable;
• Revises change-in-terms notice requirements for HELOCs and credit card accounts to include a change in the reference rate; and,
• Provides an exception from the rate reevaluation provisions applicable to credit cards when replacing LIBOR.

The Rule also provides examples of replacement indices, including SOFR and the Prime Rate as published by the Wall Street Journal. 

Whether a replacement index meets the Regulation Z standard for a replacement index being “substantially similar” to LIBOR depends on factors such as whether: (1) the consumers’ payments using the replacement index are comparable to payments using the LIBOR index; and (2) the index movements of the two indices over time are substantially similar.

Change in Terms Notice Requirements

The Rule also provides changes in disclosure requirements. Prior to the Rule, no notice was required if a change involved the reduction of any component of a charge. Creditors or issues now must provide a change-in-terms notice when the margin is reduced in conjunction with the replacement of the LIBOR index, regardless of its effect on amount paid by the customer. The notice must disclose the replacement index and the new margin.

Contractual Limitations

For existing portfolios, depending on volume and cost, financial institutions should begin to encourage customers to refinance into credit products with a LIBOR alternative. Financial institutions should also examine their credit products to make sure they understand what contractual limitations may exist that could inhibit refinance or conversion plans. Although the Rule provides guidance for financial institutions transitioning away from LIBOR, that process will also be governed by the terms of any contracts.

Early compliance with the change-in-terms notice requirements becomes effective on April 1, 2022, although it is not a requirement that the transition occurs before this date.[2] The revisions to the change-in-terms notice requirements become mandatory on October 1, 2022.

A financial institution may wish to consider outside counsel to help them navigate this complex Rule and the transition away from LIBOR.

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[1] The Rule does not permit lines of credit that are unsecured or secured by assets other than a home to be converted early to SOFR or any other comparable rate. An institution will have to wait until LIBOR is unavailable to do this.

[2] The final Rule is effective April 1, 2022 except for two post-consummation disclosure forms that are effective on October 1, 2023: the Initial and Subsequent Interest Rate Adjustment sample forms.