JPRF-F-2022-035 — Reform of the variable component of the reference rate for the adjustment of risk-free interest rates in substitution of the LIBOR rate

THE FINANCIAL POLICY AND REGULATION BOARD
CONSIDERING:
That, Article 226 of the Constitution of the Republic orders that: "The institutions of the State, their agencies, dependencies, public servants, and persons acting by virtue of a state power shall exercise only the competencies and powers attributed to them in the Constitution and the law. They shall have the duty to coordinate actions for the fulfillment of their purposes and to make effective the enjoyment and exercise of the rights recognized in the Constitution.";

That, Article 277 of the Magna Carta prescribes that: "For the achievement of good living, the general duties of the State shall be: 1. Guarantee the rights of persons, collectives, and nature. (…) 5. Promote the development of economic activities through a legal order and political institutions that promote, foster, and defend them through compliance with the Constitution and the law. (…)";

That, according to number 7 of Article 284 of the Supreme Norm, economic policy shall have as its objective, among others, the "maintain economic stability, understood as the maximum level of production and employment sustainable over time";

That, Article 302 ibidem, in its pertinent part, mandates that "Monetary, credit, exchange, and financial policies shall have as objectives: (…) 2. Establish levels of global liquidity that guarantee adequate margins of financial security. 3. Orient liquidity surpluses toward the investment required for the development of the country. (…)" and that, according to Article 303, the formulation of credit and financial policies is an exclusive faculty of the Executive Function;

That, the first paragraph of Article 308 of the Supreme Norm stipulates that financial activities are a public order service and shall have the fundamental purpose of "preserving deposits and meeting financing requirements for the achievement of the country's development objectives." In concordance, Article 309 of the Constitution of the Republic prescribes that the norms of the national financial system shall be responsible for "preserving its security, stability, transparency, and solidity."

That, Article 5 of the Organic Monetary and Financial Code, Book I, provides that the formulation of policies and regulations in monetary, credit, exchange, financial, as well as insurance and securities matters, is the exclusive faculty of the Executive Function and, ratifies, that the objectives of public policy in these matters are those determined in Articles 284 and 302 of the Fundamental Norm;

That, Article 13 of the aforementioned Organic Code, creates the Financial Policy and Regulation Board as part of the Executive Function, responsible for the formulation of credit, financial, securities, insurance, and prepaid comprehensive health care services policy and regulation;

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That, Article 14 number 2 of the aforementioned Code, regarding the scope of action of the Financial Policy and Regulation Board, mandates: "2. Issue the regulations that allow maintaining the integrity, solidity, sustainability, and stability of the national financial, securities, insurance, and prepaid comprehensive health care services systems in attention to what is provided in Article 309 of the Constitution of the Republic of Ecuador";

That, numbers 7 letter b) and 26 of Article 14.1 ibidem, establish the following: "For the performance of its functions, the Financial Policy and Regulation Board must fulfill the following duties and exercise the following faculties: (…) 7. Issue the prudential regulatory framework to which financial, securities, insurance, and prepaid comprehensive health care services entities must adhere, framework that must be coherent, not give rise to regulatory arbitrage, and cover, at least, the following: (…) b. Establish the interest rate system, as provided in Article 130 of this Code, for the active and passive operations of the national financial system and the other interest rates required by law, promoting prudent credit development: Minimum capital levels, technical equity, and risk weightings of assets, their composition, method of calculation, and modifications; (…) 26. Establish, with the purpose of stimulating development, economic reactivation, and financial stability, with adequate technical backing, the system of interest rates and provisions applicable to credit, financial, commercial, and other operations, which may be defined by segments, economic activities, and other criteria. In the execution of these parameters, the principles of financial stability and solidity shall be considered and guaranteed at all times (…)";

That, Article 130 of the Organic Monetary and Financial Code, Book I, orders that: "The Financial Policy and Regulation Board shall establish the maximum interest rate system for the active and passive operations of the national financial system and the other rates required by the Law. (…)." This faculty is in harmony with what is provided in Article 14.1, number 7 letter b) and 26 of the same legal body;

That, the Fiftieth Transitory Provision of Article 106 of the Organic Law Reforming the Organic Monetary and Financial Code for the Defense of Dollarization, published in the Official Register Supplement No. 433 of May 3, 2021, states that: "Resolutions contained in the Codification of Monetary, Financial, Securities, and Insurance Resolutions of the Monetary and Financial Policy and Regulation Board and norms issued by control bodies shall maintain their validity until the Monetary Policy and Regulation Board and the Financial Policy and Regulation Board resolve what corresponds, within the scope of their competencies.";

That, through letter No. CFN-B.P.-GG-2022-0094-OF of February 25, 2022, the General Manager, Acting, of the National Financial Corporation, submits to the President of the Financial Policy and Regulation Board the memorandum No. CFN-B.P.-GNFC-2022-0062-M of February 7, 2022, through which it requests the reform of the regulatory calendar, referring to the transition from the LIBOR rate to other reference rates;

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That, through Letter No. BCE-JPRM-2022-0070-OF of July 21, 2022, the Acting President of the Monetary Policy and Regulation Board, exercising the faculty to propose regulatory projects for consideration by the Financial Policy and Regulation Board, established in Article 14.1 of the Organic Monetary and Financial Code, submits to the President of the Financial Policy and Regulation Board the proposal for the norm modifying the LIBOR rate for operations with adjustable rates, for which it attaches the legal report No. BCE-CGJ-094-2022 and technical report No. BCE-SGPRO-048-2022/BCE-SGOPE-036-2022 both dated July 18, 2022.

That, the Technical Secretariat of the Financial Policy and Regulation Board, through memorandum No. JPRF-SETEC-2022-0059-M of July 26, 2022, submits to the President of the Board the following reports:
(i) Technical Report No. JPRF-CT-2022-00030 of July 26, 2022, concludes that the transition from a regime of LIBOR rates called theoretical due to their method of calculation, to a rate established based on the US Treasury bond repurchase market, where banks and investors lend or borrow these bonds overnight, known as the Secured Overnight Funding Rate (SOFR), is an option that serves as a reference point whose guarantee makes it a risk-free alternative to the withdrawal of the LIBOR rate. It should be noted that this conclusion is in line with the recommendations made by the Alternative Reference Rates Committee (ARRC), the Federal Reserve of the United States (Fed), and the Federal Reserve Bank of New York (NY Fed), organizations that suggest the use of SOFR (Secured Overnight Funding Rate) and for other currencies, internationally similar rates. (ii) Legal Report No. JPRF-CJ-2022-0035 of July 26, 2022, establishes that the Financial Policy and Regulation Board, as responsible for the formulation of credit and financial policy and regulation, has legal competence to establish the interest rate system for the active and passive operations of the national financial system and the other interest rates required by law. Furthermore, it points out that in attention to the change in the financial market paradigm due to the discontinuation of the LIBOR interest rate and the international adoption of other risk-free rates such as SOFR, it is necessary to safeguard the regulatory guarantee prescribed in Article 84 of the Constitution of the Republic of Ecuador;

That, the Financial Policy and Regulation Board, in ordinary session convened by technological means on July 26, 2022, and carried out via video conference on July 29, 2022, reviewed and approved the following resolution; and,

In exercise of its functions,

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RESOLVES:
SOLE ARTICLE.- Substitute Articles 31 and 32 of Subsection V "Adjustable Interest Rates", of Chapter XI "Interest Rate System and Tariffs of the Central Bank of Ecuador", of Title I "Monetary System", of Book I "Monetary and Financial System" of the Codification of Monetary, Financial, Securities, and Insurance Resolutions, with the following:

"Art. 31.- In the case of operations with adjustable interest rates, the parties shall freely agree on a variable component, which shall correspond to one of the reference rates mentioned in Articles 3 to 6 of this Chapter, in effect on the date of the start of each adjustment period, or to the PRIME, SOFR, CME TERM SOFR rates for a determined term, or a similar international reference rate in its conditions; and a fixed component, expressed in percentage points above or below the variable component. The fixed component shall remain constant throughout the entire period of the operation.

According to internationally standardized procedures, for adjustment purposes, the PRIME, SOFR, CME TERM SOFR rates for a determined term, or the similar international reference rate in its conditions to be used shall be those in effect at the start of each adjustment period. In these cases, the source of information and other necessary data to determine them with precision must be explicitly stated.

The effective rate applicable to each adjustment period shall therefore be the sum of the fixed component plus the variable component in effect at the start of the period, and with the nominal equivalent of said effective rate, the new credit installments in effect for periods subsequent to the adjustment date shall be calculated. In no case shall the effective rate applicable to each adjustment period exceed the maximum effective active rate of the corresponding segment.

When credits and other active operations are agreed upon at the adjustable interest rate, along with the effective interest rate in effect for the initial period, the following phrase shall be stated in the respective document supporting the operation: 'will vary with the adjustments of the reference interest rate.' The creditor shall inform the debtor, in each adjustment period, the new effective interest rate of that period, which in no case may exceed the maximum effective interest rate of the respective segment in effect on the date of the adjustment.

Art. 32.- The reference interest rate for loans with adjustable rates granted by the National Financial Corporation B.P. to borrowing entities, and these to their clients, within the framework of the global multisectoral credit program, shall be that defined in the agreements signed by this entity with such organizations plus the fixed component. In case this rate is not stated in the agreement, the parties shall freely negotiate the fixed component which shall be expressed in percentage points above or below, or as a percentage

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or coefficient of the PRIME, SOFR, CME TERM SOFR rates for a determined term, or the similar international reference rate in its conditions, chosen as reference.
The reference rate chosen and the fixed component agreed upon shall be stated in the document supporting the active or passive operation, and, in the case of PRIME, SOFR, CME TERM SOFR rates for a determined term, or the similar international reference rate in its conditions; the source of information and other necessary data to determine them with precision must be explicitly stated."

TRANSITORY PROVISION.- Credit contracts signed prior to the promulgation of this norm shall continue to apply the reference rates provided on the date of their celebration until their completion, unless otherwise agreed, the parties considering that the LIBOR rate will be discontinued starting June 2023.
FINAL PROVISION.- This Resolution shall enter into force from the present date, without prejudice to its publication in the Official Register. Publish this Resolution on the website of the Financial Policy and Regulation Board, within a maximum term of two days from its issuance.

NOTIFY.- Given in the Metropolitan District of Quito, on July 29, 2022.
THE PRESIDENT,
Mgs. María Paulina Vela Zambrano
The resolution above was processed and signed by Master María Paulina Vela Zambrano, President of the Financial Policy and Regulation Board, in the Metropolitan District of Quito, on July 29, 2022.- I CERTIFY.
TECHNICAL SECRETARY
Dr. Nelly Arias Zavala