ISDA® Publishes Consultation Seeking Feedback on Final Methodologies for Derivatives Benchmark Fallback Adjustments | Practical Law

ISDA® Publishes Consultation Seeking Feedback on Final Methodologies for Derivatives Benchmark Fallback Adjustments | Practical Law

ISDA launched a new consultation requesting feedback from market participants on the final parameters for the spread and term adjustments in derivatives benchmark fallbacks for key interbank offered rates (IBORs), including LIBOR..

ISDA® Publishes Consultation Seeking Feedback on Final Methodologies for Derivatives Benchmark Fallback Adjustments

by Practical Law Finance
Published on 25 Sep 2019 • USA (National/Federal)
ISDA launched a new consultation requesting feedback from market participants on the final parameters for the spread and term adjustments in derivatives benchmark fallbacks for key interbank offered rates (IBORs), including LIBOR..
On September 18, 2019, ISDA® launched a consultation (September 2019 consultation) requesting feedback from market participants, as part of ongoing benchmark reform, on the final parameters for spread and term adjustments in derivatives benchmark fallbacks for key interbank offered rates (IBORs), including LIBOR.
The consultation follows and builds upon two prior ISDA consultations on IBOR benchmark fallbacks:
Based on the results of these consultations, ISDA is developing benchmark fallbacks for inclusion in its standard definitions for derivatives that reference USD LIBOR, GBP LIBOR, CHF LIBOR, JPY LIBOR, TIBOR, Euroyen TIBOR, BBSW, HIBOR, and CDOR based on:
  • The compounded setting in arrears rate approach, which is the relevant risk-free rate (RFR) observed over a period that is generally equivalent to the relevant IBOR tenor and compounded daily during that period.
  • The historical mean/median approach to the spread adjustment, which is based on the mean or median spot spread between the IBOR and the adjusted RFR calculated over a static lookback period prior to the triggering of the benchmark fallback.
The September 2019 consultation seeks input on the potential approaches for implementing the compounded setting in arrears rate and the historical mean/median approach to the spot spread. ISDA notes that the September 2019 consultation assumes an understanding of both the July 2018 consultation and the May 2019 consultation. According to ISDA, it will use the responses to the September 2019 consultation to finalize the methodologies for the compounded setting in arrears rate and the historical mean/median approach to the spread adjustment for derivatives benchmark fallbacks.
For the compounded setting in arrears rate approach, the options are:
  • A backward-shifting adjustment, where the observation period for the RFR would be adjusted or backwards-shifted a certain number of banking days so that the fallback rate would be known in advance of the payment dates.
  • A lockout mechanism, where the RFR published a number of days before the end of a calculation period would be deemed to be the RFR for the last few days of the relevant calculation period.
For the historical mean/median approach to the spread adjustment, the following options, based on feedback from the July 2018 consultation and the May 2019 consultations, include:
  • Median over five-year lookback period from date of fallback trigger.
  • Trimmed mean over ten-year lookback period from date of fallback trigger.
The consultation includes 16 questions on which ISDA is requesting feedback. The questions relate to:
  • The historical mean/median approach to the spread adjustment, including questions about:
    • preferences of market participants;
    • the importance of consistency across IBORs;
    • the inclusion of a transitional period;
    • the exclusion of outliers; and
    • negative spread adjustments.
  • The compounded setting in arrears rate approach, including questions about:
    • the necessity of a backward-shift, lockout, or similar adjustment;
    • whether market participants would support a two-banking-day backward-shift, a two-banking-day lockout, or a different adjustment; and
    • whether two banking days would be the correct length of time for a backward shift or lockout.
In addition, according to the consultation:
  • The long-run spread adjustment will be set (in other words, not dynamic), and calculated as of the business day before the fallback trigger event occurs based on historical data as of that point in time, and will not be relevant until the fallback itself applies.
  • A fallback trigger will occur when a relevant public statement is made, or relevant information is published, regarding the permanent discontinuation of an IBOR. However, the fallback rate will not apply until the IBOR is actually discontinued. ISDA notes that it is working to develop a solution for pre-cessation events (see ISDA's recent consultation on pre-cessation issues, Legal Update, ISDA Publishes Two Consultations on IBOR Benchmark Fallbacks: Consultation on Pre-Cessation Issues).
  • As ISDA announced in July 2019, Bloomberg Index Services Limited will produce and publish the compounded setting in arrears rate, the spread adjustment, and the "all in" fallback rate, which is the compounded setting in arrears rate plus the applicable spread.
  • The ISDA benchmark fallbacks will be included in the 2006 ISDA Definitions for interest rate derivatives and will apply to future IBOR trades. ISDA will also publish a protocol to allow market participants to include the fallbacks within the legacy IBOR contracts incorporating the 2006 ISDA Definitions or the 2000 ISDA Definitions.
ISDA also notes that both the amended definitions and a related protocol are expected to be finalized by the end of 2019, with implementation in 2020.
The deadline for submitting responses to the questions included in the consultation is October 23, 2019. Responses should be emailed to [email protected], and may be submitted via this form.
In connection with the consultation, ISDA also published:
  • A press release on the consultation.
  • A report that summarizes the final results of the May 2019 consultation which found, among other things, that the majority of market participants preferred the Secured Overnight Financing Rate (SOFR) as the basis for the USD LIBOR fallback rate.
"ISDA" is a registered trademark of the International Swaps and Derivatives Association, Inc. (ISDA). ISDA is not a sponsor of Practical Law and had no part in the development of this Update.