ECB Report on Fallback Provisions in Contracts Referencing EURIBOR
ECB published a report, by private sector working group on euro risk-free rates, presenting recommendations for fallback provisions in contracts for cash products and derivative transactions referencing EURIBOR. These recommendations support compliance with the EU Benchmarks Regulation and enhance legal and commercial certainty. The working group recommends that market participants incorporate fallback provisions in all new financial instruments and contracts referencing EURIBOR, regardless of whether they fall within the scope of the Benchmarks Regulation.
The key recommendations highlight that the legacy financial instruments and contracts referencing EURIBOR that were entered into after January 01, 2018 and that fall within the scope of the Benchmark Regulation should be covered by robust written plans prepared by supervised entities in accordance with Article 28(2) of the Benchmarks Regulation. For legacy contracts that do not contain appropriately worded fallback provisions, to the extent practicable, market participants should introduce EURIBOR fallback provisions, or enhance existing provisions, when such financial instruments and contracts are next amended or updated. Where no specific fallback provisions are recommended and pending further guidance from the working group or regulatory authorities, market participants may wish to consider including generic language in their fallback provisions. To this end, the working group is recommending a standard text for a generic EURIBOR fallback provision.
The working group also highlighted the risk management implications of inconsistencies in fallback provisions and triggers and of incorporating different fallback trigger language for different asset classes and currencies. Side effects could arise from the lack of concordant language for the commonly used hedging product combinations. Market participants are recommended to consider these risks when developing trigger events and fallback provisions and assessing the feasibility and appropriateness of aligning them across asset classes and currencies.
For derivatives transactions, at the request of the Official Sector Steering Group of FSB, ISDA is developing fallbacks for derivatives referencing LIBOR, EURIBOR, and other key interest rate benchmarks (the ISDA IBOR fallbacks) to address the event of permanent cessation. In addition, ISDA published the ISDA Benchmarks supplement that market participants may incorporate into their documentation to provide primary fallbacks for derivatives in the event of the cessation of an index; the working group considers this a convenient way to include fallback provisions. Supplementary consultations on EURIBOR and pre-cessation trigger events will be held by ISDA in the coming months.
This report reminds the market participants of key messages of the January 2019 paper containing guiding principles for fallback provisions in new contracts for euro-denominated cash products. The paper provided an overview of the legal frameworks and market practices applicable to cash products, such as mortgages, loans and bonds, that reference EURIBOR and EONIA, with a specific focus on fallback clauses, and it recommended a set of guiding principles promoting the use of effective fallback provisions in new contracts for euro-denominated cash products. This report, where relevant, also provides updates that reflect market developments and practices related to cash products and derivatives transactions referencing EURIBOR.
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Keywords: Europe, EU, Banking, Securities, EURIBOR, Fallback Provisions, Benchmarks Regulation, Risk-free Rates, Interest Rate Benchmarks, Derivatives, ISDA, ECB
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