A follow-up summary of the Regulation ZZ final rule

In March of 2022, the Adjustable Interest Rate (LIBOR) Act (the “LIBOR Act”) was signed into law. The purpose of the LIBOR Act was to provide a uniform federal solution for transitioning existing contracts based on the London Interbank Offered Rate (“LIBOR”) to an alternative replacement rate before June 30, 2023, at which point LIBOR will cease to be published. In order to implement the LIBOR Act, the Board of Governors of the Federal Reserve System (the “Board”) proposed to enact Regulation ZZ (Regulations Implementing the Adjustable Interest Rate (LIBOR) Act), which would specifically address “tough legacy contracts,” which are LIBOR contracts that will not mature by June 30, 2023, cannot be easily amended, and lack adequate fallback provisions for determining a replacement benchmark. We previously provided a discussion and summary of proposed Regulation ZZ (the “Proposed Rule”), which can be found here: Proposed Regulation ZZ’s LIBOR transition rules for tough legacy contracts. 

On December 16, 2022, following the comment period for the Proposed Rule, the Board announced that it had adopted a final Regulation ZZ to implement the LIBOR Act (the “Final Rule”). The Final Rule is substantially similar to the Proposed Rule discussed above, with a few differences as described below:

1. Definition of “determining person” and selecting a benchmark replacement
   Among other specified types of contracts, Regulation ZZ applies to contracts which contain LIBOR fallback language, but do not identify a specific benchmark replacement nor a “determining person.” Thus, it is important to understand who would meet the definition of a “determining person.”
   
   Under the Proposed Rule, the term “determining person” included only those individuals with the authority, right, or obligation (including on a temporary basis) to determine a replacement rate. However, the Proposed Rule made no mention of whether the “determining person” must have a current authority, right, or obligation to determine a benchmark replacement, or whether a person with a contingent authority, right, or obligation to determine a benchmark replacement would qualify. In the Final Rule, the Board clarified this ambiguity by stating that a determining person may possess temporary or contingent authority so long as the individual has sole authority to determine the benchmark replacement.
   
   Additionally, the Board clarified that a determining person who selects a Board-selected benchmark replacement pursuant to the authority and statutory protections of the LIBOR Act must choose the Board-selected benchmark replacement identified in Regulation ZZ for that contract type.
    
2. Covered vs non-covered contracts
   
   The Proposed Rule defined contracts that would be subject to Regulation ZZ as “covered contracts,” which were split into three sub-categories based on a contract’s characteristics; whereas contracts that would not be subject to Regulation ZZ were considered “non-covered” contracts. The commenters indicated that these definitions did not fully align with the LIBOR Act and were confusing. Thus, the Final Rule excluded these definitions.
    
3.  Synthetic LIBOR
   
   Following the publication of the Proposed Rule, the Board solicited comments regarding the potential publication of a synthetic version of LIBOR (“Synthetic LIBOR”) after June 30, 2023. Synthetic LIBOR would be a rate that carries the LIBOR name, but would not be representative of the underlying market and economic reality that LIBOR had been intended to measure (i.e., the rate at which banks may lend to, or borrow from, other banks or agents in the money markets). After reviewing the comments to the Proposed Rule, the Board explained that if a contract contains fallback provisions that identify a specific non-LIBOR benchmark replacement, it would fall outside the scope of the LIBOR Act entirely. However, if a contract contains language authorizing a person to select a benchmark replacement only when LIBOR is unavailable, a person with a contingent authority, right or obligation to determine a benchmark replacement would be a “determining person” (see paragraph 1 above), and such “determining person” has a statutory right under the LIBOR Act to select the Board-selected 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. If the determining person fails to select a benchmark replacement by the LIBOR replacement date, the applicable Board-selected benchmark will be the benchmark replacement for the LIBOR contract. As such, Synthetic LIBOR should not present complications to Regulation ZZ.

The Final Rule will take effect 30 days after its publication in the Federal Register.

Sam Brand is an associate in the Firm's banking and commercial finance group. Sarah Wade and Garrett Fischer are partners in the Firm's Banking practice.