ISDA® Publishes Two Consultations on IBOR Benchmark Fallbacks | Practical Law

ISDA® Publishes Two Consultations on IBOR Benchmark Fallbacks | Practical Law

ISDA published two market-wide consultations as part of ongoing interest rate benchmark reform, one seeking further input on adjustments that would apply to fallback rates in the event certain interbank offered rates (IBORs) are discontinued, and another on pre-cessation issues in derivatives that reference LIBOR and certain other IBORs.

ISDA® Publishes Two Consultations on IBOR Benchmark Fallbacks

Practical Law Legal Update w-020-4641 (Approx. 6 pages)

ISDA® Publishes Two Consultations on IBOR Benchmark Fallbacks

by Practical Law Finance
Published on 23 May 2019 • USA (National/Federal)
ISDA published two market-wide consultations as part of ongoing interest rate benchmark reform, one seeking further input on adjustments that would apply to fallback rates in the event certain interbank offered rates (IBORs) are discontinued, and another on pre-cessation issues in derivatives that reference LIBOR and certain other IBORs.
On May 16, 2019, as part of ongoing interest rate benchmark reform, ISDA® published two market-wide consultations:
ISDA has been leading the work on the implementation of new interest rate benchmark fallbacks, as derivatives contracts are some of the most IBOR/LIBOR-dependent financial contracts, in the wake of the global LIBOR-rigging scandal, which elicited a call by the Financial Stability Board (FSB) in July 2014 to reform interest rate benchmarks in order to avoid market disruption in the event the main IBORs including LIBOR are permanently discontinued (see Legal Update, FSB report on reforming major interest rate benchmarks).
The fallbacks referenced in the ISDA consultations will be to RFRs that have been identified for relevant IBORs as part of recent global benchmark reform work. For details on the alternative RFRs, see Legal Updates, Fed Committee Announces GC Repo Rate as LIBOR Alternative for Financial Contracts, Fed Requests Comment on Proposed LIBOR Alternatives, and New York Fed Publishes New Benchmarks.
ISDA plans to publish a Supplement to the 2006 ISDA Definitions (2006 Definitions) that will amend certain floating rate options in Section 7.1 of the 2016 Definitions to include fallbacks that would apply if a specified IBOR is permanently discontinued (see Standard Document, ISDA® Market Agreed Coupon (MAC) Interest Rate Swap Transaction Confirmation (Annotated), Drafting Note, Floating Rate Option for an explanation of floating rate options under the definitions).
This 2019 consultation is a supplementary consultation to the benchmark fallbacks consultation that ISDA launched in July 2018 (see Legal Update, Updated: ISDA® Releases Consultation on Technical Issues Related to Benchmark Fallbacks). Results from that consultation were published in December 2018 (see Legal Update, ISDA® Publishes Final Results of Benchmark Fallback Consultation).
In connection with the ISDA consultations, ISDA published:
  • A press release on the ISDA consultations.
  • A webinar, introducing the ISDA consultations.
  • A set of graphs illustrating the options for adjustments discussed in the 2019 consultation.
ISDA has also been involved in releasing FAQs and resources to assist market participants with the benchmark transition. For details on these resources, see Legal Updates, ISDA® Releases FAQs on IBOR Fallback Rates and ISDA®/SIFMA Release Roadmap to Assist with Benchmark Transition.

Consultation on Spread and Term Adjustments for Fallbacks

In July 2018, ISDA published a consultation (the 2018 consultation), seeking comments from market participants on an optimal approach to calculate the applicable RFRs if fallbacks are triggered for any of the following rates: GDP LIBOR, CHF LIBOR, JPY LIBOR, TIBOR, Euroyen TIBOR, or BBSW (see Legal Update, Updated: ISDA® Releases Consultation on Technical Issues Related to Benchmark Fallbacks).
Feedback from the 2018 consultation identified the following two approaches as the preferred approaches for addressing certain technical issues associated with fallbacks for the above-listed IBORs:
  • The compounded setting in arrears rate approach, for facilitating the transition from IBORs for RFRs.
  • The historical mean/median approach, for calculating the corresponding spread adjustment.
For details on the results of the 2018 consultation, see Legal Update, ISDA® Publishes Final Results of Benchmark Fallback Consultation.
The 2019 consultation covers USD LIBOR, CDOR, and HIBOR, and seeks feedback to determine the approach for calculating the adjusted RFRs and spread adjustments that would apply if fallbacks are triggered for these rates.
The 2019 consultation seeks input on the optimal approach for adjustments that would apply to the fallback rates for USD LIBOR, CDOR, and/or HIBOR, with the same options as set out in the 2018 consultation. As in the 2018 consultation, the four options to facilitate the transition from IBORs to RFRs are:
  • A spot overnight rate.
  • A convexity adjusted overnight rate.
  • A compounded setting in arrears rate.
  • A compound setting in advance rate.
The three options for calculating the spread adjustment are:
  • A forward approach.
  • A historical mean/media approach.
  • A spot-spread approach.
Based on responses to this consultation, ISDA will determine the approach to implement and whether this will be the same approach to the IBORs discussed in the 2018 consultation.
In addition, since USD LIBOR is used to calculate the Singapore Dollar Swap Offer Rate (SOR), which is an FX swap implied interest rate, a cessation of USD LIBOR would result in a cessation of SOR. The 2019 consultation also seeks feedback on the use of "Adjusted SOR" as a fallback for SOR if USD LIBOR ceases and fallbacks to an adjusted SOFR take effect in USD LIBOR derivatives.
The deadline for response to the 2019 consultation is July 12, 2019, and ISDA notes that this deadline will not be extended. Responses should be emailed to [email protected], or submitted via the form on ISDA's website.

Consultation on Pre-Cessation Issues

The pre-cessation consultation seeks input on the preferred approach for addressing pre-cessation issues in derivatives that reference LIBOR and certain other IBORs. According to the consultation, derivative markets are expected to transition away from the IBORs before they are discontinued, allowing market participants to agree on the precise terms that apply to the transition.
The consultation notes that Edwin Schooling Latter, Director of Markets and Wholesale Policy at the FCA, delivered a speech in January 2019 in which he stated that the FCA considers “the best and smoothest transition from LIBOR will be one in which contracts that reference LIBOR are replaced or amended before fallback provisions are triggered” (see Legal Update, FCA speech on LIBOR transition and contractual fallbacks).
In addition, the FSB has asked ISDA to consult on potential pre-cessation triggers, including a scenario in which the FCA finds LIBOR to be a non-representative benchmark, but which does not result in a prohibition on the use of the benchmark under the EU Benchmarks Regulation.
ISDA is therefore seeking comment on certain pre-cessation issues including:
  • Scenarios in which a benchmark is found to be non-representative. The FCA may make an assessment and corresponding statement that a benchmark such as LIBOR is no longer representative of an underlying market, but which would not necessarily result in a prohibition on the use of the benchmark under the EU Benchmarks Regulation. Such a statement may result in market participants seeking to discontinue use of that benchmark in their derivatives contracts.
  • Whether a pre-cessation trigger related to the representativeness of a benchmark should be included in fallback language for new cash products. (Note that the Alternative Reference Rates Committee (ARRC) has published recommended template fallback language for permanent cessation triggers, as well as certain pre-cessation triggers. See, for example, Legal Update, ARRC Recommends Fallback Benchmark-Replacement Language for Syndicated Loans and Floating Rate Notes.)
  • Whether market participants would be able to include pre-cessation triggers and related fallbacks in existing cash products.
  • Whether market participants would be able to include pre-cessation triggers and related fallbacks in new derivatives that hedge those cash products.
  • Whether ISDA should include pre-cessation triggers, such as those suggested by ARRC for new cash products, in the amendments to the 2006 ISDA Definitions and in the protocol that it intends to publish.
ISDA will use the responses to these questions to determine what protocols or other documentation solutions would be most useful and appropriate for derivatives market participants to use in addressing IBOR pre-cessation issues.
The deadline for responses to the pre-cessation consultation is July 12, 2019, and ISDA notes that this deadline will not be extended. Responses should be emailed to [email protected], or submitted via the form on ISDA's website.
"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.