ISDA® Publishes Results of Consultation on Final Methodologies for Derivatives Benchmark Fallback Adjustments | Practical Law

ISDA® Publishes Results of Consultation on Final Methodologies for Derivatives Benchmark Fallback Adjustments | Practical Law

ISDA published a report summarizing the responses to its September 2019 consultation on the final parameters for spread and term adjustments in derivatives benchmark fallbacks for key interbank offered rates (IBORs), including LIBOR.

ISDA® Publishes Results of Consultation on Final Methodologies for Derivatives Benchmark Fallback Adjustments

by Practical Law Finance
Published on 21 Nov 2019 • USA (National/Federal)
ISDA published a report summarizing the responses to its September 2019 consultation on the final parameters for spread and term adjustments in derivatives benchmark fallbacks for key interbank offered rates (IBORs), including LIBOR.
On November 15, 2019, ISDA® published a report summarizing the responses to its September 2019 consultation on the final parameters for spread and term adjustments in derivatives benchmark fallbacks for key interbank offered rates (IBORs), including LIBOR (see Legal Update, ISDA Publishes Consultation Seeking Feedback on Final Methodologies for Derivatives Benchmark Fallback Adjustments).
The report, which was prepared by the Brattle Group, included responses from 90 respondents from 17 countries operating in various areas of the market. The report found that market participants preferred:
  • A historical median approach to the spread adjustment over a five-year lookback period that:
    • does not include a transitional period in the spread adjustment calculation;
    • does not exclude outliers; and
    • does not exclude any negative spreads.
  • For the compounded setting in arrears rate, a two-banking-day backward-shift adjustment period for operational and payment purposes, defined by reference to either:
    • the city relating to the rate; or
    • the banking days for which the respective risk-free rate (RFR) is published.
In addition, the report also found that:
  • About half of respondents stated that they would not be "opposed or harmed by" an option that was not their top choice for calculating a spread adjustment.
  • A majority of respondents thought that the consistency of calculation method for the spread adjustment across IBORs was either "critical or very important," and that “consistency across IBORs was more important than their top choice for calculating the spread adjustment.”
  • Though a majority of respondents preferred a backward-shift adjustment over a lockout or other adjustment, with 26% of respondents considering the lockout method to be problematic, approximately 14% of respondents indicated that the backward shift was "potentially problematic."
According to ISDA, and based on the feedback, it expects to publish:
  • Amendments to the 2006 ISDA Definitions for interest rate derivatives to incorporate fallbacks with these adjustments for new IBOR trades.
  • A protocol to enable market participants to include fallbacks within legacy IBOR contracts.
Both the amendments and protocol are expected to be finalized by the end of 2019, with implementation in 2020. Bloomberg will publish the spread adjustments and the "all in" fallback rates.
ISDA states in the report that, in accordance with the results:
  • The spread adjustment in the 2006 Definitions will be a historical median spread adjustment:
    • over a five-year lookback period;
    • that does not include a transitional period;
    • does not exclude outliers; and
    • does not exclude negative spreads.
  • The spread adjustment will be applied to a compounded in arrears rate with the applicable calendar to be determined and announced by Bloomberg.
  • ISDA expects that the two-banking-day backward shift adjustment period will apply.
  • Bloomberg and ISDA will publish the mathematical formulas for the spread adjustment and compounded in arrears rate prior to publication and implementation.
In addition, ISDA also expects to publish a new supplemental consultation on the spread and term adjustments for fallbacks in derivatives referencing euro LIBOR and EURIBOR. If the results from this supplemental consultation are consistent, ISDA intends to implement fallbacks for euro LIBOR and EURIBOR at the same time as the fallbacks covered by the previous consultations.
The September 2019 consultation followed ISDA’s July 2018 and May 2019 consultations (see Legal Updates, ISDA Publishes Two Consultations on IBOR Benchmark Fallbacks and ISDA Releases Consultation on Technical Issues Related to Benchmark Fallbacks), which showed that market participants preferred:
  • The compounded setting in arrears rate to address the different in tenors between IBORs and overnight RFRs.
  • The historical mean/median approach for the spread adjustment to "address credit risk and other premia between IBOR and corresponding RFRs across benchmarks."
ISDA also published a press release on the report.
"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.