On July 12, the International Swaps and Derivatives Association (ISDA) published a document entitled Consultation on Certain Aspects of Fallbacks for Derivatives Referencing GBP LIBOR, CHF LIBOR, JPY LIBOR, TIBOR, Euroyen TIBOR and BBSW (Bank Bill Swap Rate) that is intended to solicit market input on how the derivatives markets can best create alternatives to the interbank offered rates (IBORs) currently referenced in derivatives transactions. This is one of many current market initiatives that are responding to the likelihood that many IBORs will cease to be published or cease to have appropriate liquidity after 2021 and must therefore be replaced by new benchmark rates based on the overnight risk-free rates (RFRs) that are being adopted for each major currency.
The Consultation complements ISDA’s plans to amend the standard 2006 ISDA Definitions to define the permanent discontinuance of a benchmark rate and to provide fallbacks for such an eventuality. These plans contemplate that the fallback rate for each currency will be the relevant RFR adjusted using methodologies to account for (1) the fact that the RFR is an overnight rate and (2) the various premiums (including credit spreads) included within the IBOR that has been discontinued. Once the discontinuance trigger has been defined and the fallbacks have been identified, ISDA anticipates that it will publish a protocol to assist the market in amending swap documentation to introduce the new rates.
The Consultation sets out four options for choosing a base RFR for use in creating term rates comparable to a discontinued benchmark rate. It then discusses various methodologies for adjusting the base RFR for the credit and other spreads in the replaced benchmark. The methodologies were identified based on the following criteria: (1) eliminating or minimizing value transfer at the time the fallback is applied; (2) eliminating or minimizing any potential for manipulation; and (3) eliminating or mitigating against the impact of market disruption at the time the fallback is applied.
ISDA highlights two important points in the Consultation:
- The Consultation covers only GBP LIBOR, CHF LIBOR, JPY LIBOR, TIBOR, Euroyen TIBOR and BBSW. ISDA says it will launch supplemental consultations covering USD LIBOR, EUR LIBOR and EURIBOR, but requests preliminary feedback on the technical issues associated with fallbacks for these benchmarks in this consultation.
- ISDA notes that efforts are also underway globally to implement fallbacks for other products (e.g., loans, bonds, notes) that reference IBORs, but the Consultation does not discuss or cover whether the adjusted RFRs and spread adjustments it proposes would be appropriate for fallbacks in those other products. (Logically, however, the optimal result will be to have the same fallback used for all purposes.)
ISDA will accept responses to the Consultation until October 12.
The Consultation is available here: