ARRC Releases Recommendations on Benchmark Conversion for Interdealer Cross-Currency Swaps | Practical Law

ARRC Releases Recommendations on Benchmark Conversion for Interdealer Cross-Currency Swaps | Practical Law

The Alternative Reference Rates Committee (ARRC) released preliminary recommendations for benchmark conversion in interdealer cross-currency swaps.

ARRC Releases Recommendations on Benchmark Conversion for Interdealer Cross-Currency Swaps

by Practical Law Finance
Published on 02 Jul 2019 • USA (National/Federal)
The Alternative Reference Rates Committee (ARRC) released preliminary recommendations for benchmark conversion in interdealer cross-currency swaps.
On June 24, 2019, the Cross-Currency Swaps Subgroup of the Alternative Reference Rates Committee's (ARRC's) Market Structures working group released preliminary recommendations for benchmark conversion conventions in interdealer cross-currency swaps. The report includes recommendations on:
  • Potential conventions for dealer-to-dealer cross-currency basis swaps between two alternative risk-free rates (RFRs).
  • Potential conventions for dealer-to-dealer cross-currency basis swaps between a RFR and an interbank offered rate (IBOR).
  • Potential fallbacks for cross-currency swaps that currently reference IBORs.
Interdealer cross-currency swaps that reference USD LIBOR and other interbank IBORs will need to be transitioned to alternative RFRs in the event that LIBOR is discontinued, as is anticipated to occur at some point after 2021 (see, for example, Legal Update, ARRC Recommends Fallback Benchmark-Replacement Language for Syndicated Loans and Floating Rate Notes).
The report encourages feedback from market participants on potential conventions for interdealer trading of RFR-RFR and RFR-IBOR cross-currency swaps. The report also notes that ISDA® is considering a template that would facilitate the transition of both legs of a legacy cross-currency swap referencing IBORs to successor rates at the same time.
According to the report, the potential conventions for liquid RFR-RFR dealer-to-dealer transactions include:
  • Quarterly payments on each leg of the swap.
  • Exchange of notional principal cash flows at the start and maturity dates of the swap.
  • Compound daily rates settled in arrears, using the day count convention of the underlying Overnight Index Swap (OIS) market of each currency.
  • Alignment of payment dates.
  • A spot (2 business days) start, to align with current market conventions.
  • No recommended standard on reset of notional principals (though most of the subgroup thought that quarterly resetting would likely become de facto standard).
  • No recommended standard for discounting and price alignment interest (PAI), though most of the subgroup thought that there should be a standard convention for quoting prices (which would likely be based on USD discounting).
The potential conventions for an RFR-IBOR dealer-to-dealer cross-currency basis swap include:
  • As a standard, the RFR conventions in the RFR-IBOR cross-currency market should match RFR accrual conventions that develop in the RFR-RFR cross-currency market.
  • As a standard, the IBOR leg of the RFR-IBOR cross-currency market should match the conventions developed in the related IBOR currency.
  • Aligning accrual conventions with cash products.
The report also notes that, for potential fallbacks for cross-currency swaps currently referencing IBORs, if counterparties transition from LIBOR to RFRs, either because the fallbacks are triggered or the counterparties agree to the transition, they will need to decide whether to move both benchmarks or just in the impacted leg only. The report notes that ISDA is contemplating both definitional changes as well as the addition of a new template to assist counterparties in these transitions (see Legal Update, ISDA Publishes Two Consultations on IBOR Benchmark Fallbacks).