Introduction to the ISDA Benchmarks Supplement. In September, ISDA published the ISDA Benchmarks Supplement (the "Benchmarks Supplement") primarily in order to aid parties addressing certain requirements in Article 28(2) of the EU Benchmark Regulation ("EU BMR") but also to help implement the guidance contained in the Statement on Matters to Consider in the Use of Financial Benchmarks (the "IOSCO Statement")7 published on January 5, 2018, by the Board of the International Organization of Securities Commissions ("IOSCO").

The Benchmarks Supplement, although aimed primarily at addressing Article 28(2) of the EU BMR, has been drafted generally and may therefore also be used by market participants not subject to the EU BMR, who wish to incorporate its provisions. Furthermore, as opposed to supplements generally applicable to ISDA definitions and provisions, the Benchmarks Supplement is an optional supplement that does not apply automatically; so parties will need to explicitly incorporate the Benchmarks Supplement in order for its provisions to apply. Future updates of the Benchmark Supplement will be published by the ISDA from time to time in order to include additional definitions and provisions.

Requirements under EU BMR. Article 28(2) of the EU BMR requires EU supervised entities that use a benchmark to produce and maintain robust written plans, setting out the actions they would take in the event that a benchmark materially changes or ceases to be provided. Where feasible and appropriate, those plans must nominate one or several alternative benchmarks that could be referenced to substitute the benchmarks no longer provided, indicating why such benchmarks would be suitable alternatives. These plans must be reflected in the contract with clients.

The EU BMR also provides that a supervised entity cannot use a benchmark or a combination of benchmarks in the EU unless the benchmark or the administrator, as required, is included in the European Securities and Markets Authority's register of administrators and benchmarks.

Finally, Article 35 of the EU BMR provides that if a competent authority withdraws the authorization or registration of an administrator of a benchmark, then Article 28(2) shall apply.

Requirements under IOSCO Statement. IOSCO's Statement on Matters to Consider in the Use of Financial Benchmarks focuses on contractual robustness in relation to financial instruments that reference benchmarks. In this context, it provides that users of benchmarks should consider (i) the appropriateness of a benchmark before using it and (ii) contingency plans in the event a benchmark is no longer available or materially changes, in order to mitigate risks. This is similar to the requirements of Article 28(2) of the EU BMR and provides that, where feasible and appropriate, contingency plans for the cessation of a benchmark should include sufficiently robust fallback provisions in financial contracts and instruments which should ideally involve at least one alternative fallback rate and/or figure as a substitute for the original benchmark.

Approach of the Benchmarks Supplement. The Benchmarks Supplement is relevant for transactions which incorporate one or more of the following ISDA definitions:

  • the 2006 ISDA Definitions;
  • the 2002 ISDA Equity Derivatives Definitions (Equity Definitions);
  • the 1998 FX and Currency Option Definitions (FX Definitions); and
  • the 2005 ISDA Commodity Definitions (Commodity Definitions).

The Benchmarks Supplement contains several trigger events in connection with benchmarks and fallbacks, which apply upon the occurrence of one of such triggers. The approach taken in relation to each relevant set of ISDA definitions depends on the provisions already included in the definitions.

Effect of Benchmarks Supplement on transactions that incorporate the 2006 ISDA Definitions. With regard to fallbacks, the Benchmarks Supplement makes contracts more robust by providing for scenarios of permanent cessation, something that the 2006 ISDA Definitions lacked. Also, the Benchmarks Supplement presents a new permanent cessation trigger (referred to as an "Index Cessation Event") for transactions subject to the 2006 ISDA Definitions. Likewise, it introduces a novel trigger event (referred to as an "Administrator- Benchmark Event") applicable in cases in which a benchmark or an administrator is not approved and therefore applicable laws and regulations (including where any such approval is suspended or withdrawn) ban its use.

Generally, the Benchmarks Supplement demands that parties to a transaction consider several fallbacks (referred to as "Alternative Continuation Fallbacks") upon the occurrence of an Index Cessation Event or an Administrator-Benchmark Event. There is a hierarchy in place in case more than one of these fallbacks can be utilized to allow the transaction to carry on. The Alternative Continuation Fallbacks are:

  • Agreement between the parties.
  • Use of a replacement benchmark nominated by the parties at the time of trading, plus an Adjustment Payment/Adjustment Spread.
  • Use of a substantially equivalent replacement benchmark nominated by the administrator or use of a benchmark nominated by a Relevant Nominating Body (the "Alternative Post-nominated Index"), plus an Adjustment Payment/Adjustment Spread. A "Relevant Nominating Body" is a relevant supervisor, central bank or any working group or committee officially endorsed or convened by a relevant supervisor, central bank, group of supervisors/central banks, the Financial Stability Board or part thereof.
  • Use of a replacement benchmark nominated by the Calculation Agent, plus an Adjustment Payment/Adjustment Spread.

Effect of Benchmarks Supplement on transactions that incorporate the Equity Definitions. As for the 2016 ISDA Definitions, the Benchmarks Supplement introduces an Administrator-Benchmark Event as a new trigger event and related fallbacks. In compliance with Article 20(2) of the EU BMR, it also introduces a mechanism by which parties can nominate one or several alternative benchmarks that can be used to substitute the original benchmark following the permanent cancellation of the index or an Administrator-Benchmark Event.

Effect of Benchmarks Supplement on transactions that incorporate the FX Definitions. The Benchmarks Supplement applies the existing trigger event and related fallbacks for scenarios where it is not possible to obtain the "Settlement Rate" to deliverable transactions that use a benchmark. Also, the Benchmarks Supplement contains an acknowledgement that if a benchmark changes, unless otherwise agreed, references to a benchmark will be to that benchmark as changed.

Effect of Benchmarks Supplement on transactions that incorporate the Commodity Definitions. The Benchmarks Supplement incorporates an Administrator-Benchmark Event trigger into transactions which incorporate the Commodity Definitions. Upon the occurrence of an Administrator-Benchmark Event, the fallbacks for it that are specified in the confirmation will apply or, if none, those specified for the permanent discontinuance or unavailability of a commodity reference price will apply. Failing this, the deemed fallbacks in the Commodity Definitions apply. The Benchmarks Supplement is available at https://goo.gl/yTgDrn.

For structured notes that reference the performance of a benchmark, and where the issuer is entering into a countervailing hedging transaction in order to hedge its exposure arising in connection with the issuance of the structured notes, market participants should take into account that the terms of the hedging arrangement may be affected by the implementation of the Benchmarks Supplement.

Originally published in REVERSEinquiries: Volume 1, Issue 7.

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