ISDA Consults Again on Implementing Pre-Cessation Derivative Fallbacks
ISDA launched a new consultation on the implementation of pre-cessation fallbacks for derivatives. The new consultation asks whether the 2006 ISDA Definitions should be amended to include fallbacks that would apply to all covered derivatives following the permanent cessation of an interbank offered rate (IBOR) or a non-representative pre-cessation event, whichever occurs first. The new consultation is open until March 25, 2020. ISDA aims to publish the results of this consultation, along with the information on next steps, in late April or early May.
ISDA intends to amend the 2006 ISDA Definitions by publishing a supplement to the 2006 ISDA Definitions. The supplement will implement the fallbacks by amending and restating the relevant rate options for London Interbank Offered Rate (LIBOR) in each currency in which it is published (such as USD, GBP, CHF, JPY, and EUR) and for the other IBORs for which ISDA is implementing fallbacks. On publication of the supplement, all transactions incorporating the 2006 ISDA Definitions that are entered into on or after the effective date of the supplement will include the amended terms. Transactions entered into prior to the effective date of the supplement (so called legacy derivative contracts) will continue to be based on the 2006 ISDA Definitions as the 2006 ISDA Definitions existed at the time of trading and, therefore, will not include the updated fallback provisions.
However, ISDA also intends to publish a protocol to facilitate multilateral amendments to incorporate the amended terms, and therefore the fallback provisions, in legacy derivative contracts. By adhering to the protocol, market participants would agree that all of their legacy derivative contracts, with all other adherents, will include the amended terms. Therefore, these contracts will include the same fallback provisions that will be included in transactions entered into after the effective date of the supplement and will incorporate the amended 2006 ISDA Definitions, except to the extent that two adherents separately bilaterally negotiate different terms. Also, adherence to any such protocol will be voluntary and will only amend contracts between two adhering parties.
LIBOR and the other IBORs for which ISDA is implementing fallbacks are published in various tenors and incorporate bank credit risk premia and a variety of other factors. To account for these differences in the event that the fallback provisions apply (whether as the result of a non-representativeness determination or permanent cessation), each overnight rate will be subject to two adjustments. First, the overnight rate will be compounded in arrears over the tenor of the relevant IBOR (for example, one month, three months). Then, a spread adjustment will be added to the compounded rate. For LIBOR, the spread adjustment will be calculated based on the median of the historical differences between LIBOR in the relevant currency for the relevant tenor and the corresponding fallback rate compounded over a time period with the same length as the tenor, over a five-year period prior to the announcement triggering the fallbacks.
ISDA announced its decision to consult on the pre-cessation issues on February 05, following the statements from FCA, ICE Benchmark Administration (IBA), and LCH that provided additional information to the market on this topic. The statements and this new consultation follow a 2019 consultation that was unable to find market consensus on how to implement pre-cessation fallbacks in derivatives contracts.
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Comment Due Date: March 25, 2020
Keywords: International, Banking, Securities, Insurance, Pre-Cessation Triggers, Fallback Provisions, ISDA Definitions, IBORs, Benchmark Reforms, ISDA
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