ISDA Responds to EC Proposal on Statutory Replacement Rate for EONIA
The International Swaps and Derivatives Association (ISDA) submitted a response to the draft Implementing Act of the European Commission on the statutory replacement rate for European Overnight Index Average (EONIA), a fallback of €STR plus 8.5 basis points. The response discusses the limited scope of power to designate a statutory replacement and the need to avoid a presumption of contractual frustration for contracts without an incorporated fallback. Furthermore, ISDA stressed the importance of adopting the Implementing Act in a timely manner, in light of the cessation of EONIA, which is scheduled for January 03, 2022. In terms of next steps, EC will need to adopt a final Implementing Act prior to its publication in the Official Journal of the European Union, with the regulation coming into force 20 days after its publication.
Article 23a of the Benchmarks Regulation limits the effect of the designation of a statutory replacement. On this basis and in terms of derivatives contracts, the amount of exposure to EONIA within contracts that would therefore fall out of the scope of the statutory designation is therefore very significant and is likely to greatly exceed the amount of exposure contained in contracts that would fall into scope. Even for contracts, the parties to which are all established in EU, that reference a benchmark and for contracts that are subject to the law of a third country where that law does not provide for the orderly wind-down of a benchmark, the question of whether or not the statutory designation will be effective under that third country law may vary from jurisdiction to jurisdiction, party to party and contract to contract. To avoid a situation in which parties to contracts do not take advantage of initiatives such as ISDA’s EONIA protocol or bilateral amendment templates in the mistaken belief that their out-of-scope contracts will benefit from the EC designation, this limitation on scope should be clearly flagged in the Implementing Act, the ISDA notes in its response.
Also, the current wording of the Draft Implementing Regulation could facilitate an argument that contracts that do not have a fallback face a serious risk of contractual frustration. Whether or not this is factually accurate will vary on a jurisdiction by jurisdiction, party by party. and contract by contract basis; however, regardless of the merits of the argument, saying as much in an Implementing Regulation may make it easier for litigants to argue that contracts outside the scope of this power should be held to be frustrated. Even if these arguments are defeated in court, the disruption posed by such disputes could be significant. To reduce this risk, ISDA has suggested several drafting changes to the text of the Draft Implementing Regulation.
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Keywords: International, EU, Banking, Securities, EONIA, €STR, Benchmark Reforms, Interest Rate Benchmarks, Benchmarks Regulation, EC, ISDA
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