Following up on our past posts, this update on the transition away from LIBOR (London Interbank Offering Rate), and other interbank offering rates (“IBOR”) denominated in other currencies, concerns the Alternative Reference Rates Committee (“ARRC”), and the adoption by Freddie Mac and Fannie Mae (which are US government-sponsored enterprises in the housing finance market) of the ARRC Recommendations Regarding More Robust LIBOR Fallback Contract Language for New Closed-End, Residential Adjustable Rate Mortgages, (the “ARRC’s Recommendation”) published on November 15, 2019.
The ARRC is a group of private sector market participants organized by the Board of Governors of the Federal Reserve System (“FRB”) and the New York Federal Reserve Bank (“FRBNY”) to help facilitate a successful transition from LIBOR to its recommended alternative, the Secured Overnight Financing Rate (“SOFR”). The ARRC’s Recommendation proposes new recommended fallback language for the cessation of LIBOR in closed-end residential adjustable rate mortgages. Following the release of the ARRC’s Recommendation, Fannie Mae announced in a Fannie Mae press release that it will replace LIBOR with the SOFR and will adopt this recommended fallback language for new U.S. Dollar closed-end residential adjustable rate mortgages. Freddie Mac released a nearly identical Fannie Mac press release also announcing its adoption of the SOFR and the ARRC’s Recommendation.
The ARRC’s Recommendation explains that, currently, most closed-end residential adjustable rate mortgages have fallback language for LIBOR that is extremely broad, simply “allow[ing] lenders to replace the index if LIBOR is no longer available, but provides little guidance to the parties about the process for making any such replacement.”
The new language is “intended to be consistent with its recommendations for other cash products, but it recognizes the need for simpler contract language in consumer products” and is more specific and robust than the current fallback language. The replacement language clearly defines an event (a “Replacement Event”) that triggers the use of a replacement index. The Replacement Event occurs (a) if LIBOR is no longer being provided to the general public, or (b) if LIBOR is no longer reliable or representative. First, the replacement index should be the rate selected or recommended by the FRB or the FRBNY, or a body convened or endorsed by either of them. Second, if such a replacement rate is not available, the note holder will choose a replacement index, but the language “address[es] any necessary adjustment of a loan’s margin and provides a standard of reasonableness and good faith for the Note Holder’s choice of the replacement index and margin.”
“The LIBOR Transition” is a periodic series of updates discussing reference interbank offering rates, such as LIBOR, and the challenges involved in navigating a successful transition from their use as reference rates of choice in the market. Norton Rose Fulbright has assembled a group of its lawyers from around the globe to stay on top of these issues and assist clients in the transition to new reference rates. More information can be found on our Norton Rose Fulbright web site.