Five trade associations – the International Swaps and Derivatives Association (ISDA), the Association of Financial Markets in Europe (AFME), the International Capital Market Association (ICMA), and SIFMA and its asset management group SIFMA AMG – published a "roadmap" outlining challenges for transitioning from Interbank Offered Rates ("IBORs") to risk free rates ("RFRs"). The roadmap provides a centralized source of information concerning the work being done across several market sectors at major regulatory bodies and working groups to prepare for the transition.
In addition to serving as a key educational resource for a broad range of market participants, the roadmap sets forth some of the key challenges involved in the transition, including:
- Developing liquidity in derivatives markets referencing alternative RFRs is a key to adoption, which will require exchanges and central counterparty clearinghouses to list and clear products referencing the alternative RFRs and to offer price alignment interest and discounting based on the alternative RFRs. Such liquidity will also be necessary for the development of term structures based on the alternative RFRs.
- The transition of legacy contracts potentially could result in less effective hedges and/or market valuation issues, and may require adjustments to address inherent differences between IBORs and alternative RFRs.
- The transition to RFRs may result in changes to tax, regulatory and/or accounting treatment of transactions. For example, current margining requirements may be triggered for existing derivatives transactions if they transition to alternative RFRs.
- The transition will require institutions to assess and make changes in their operations, infrastructure and governance procedures.
- Conversion of legacy contracts may require amendments to other contractual terms, leading to additional transition costs and increased operational risk. Diverging interests for stakeholders may lead to partial adoption and basis risk. Parties may be resistant to transitioning to an alternative RFR if it would result in a breach of contractual terms or an obligation to take certain actions.
The five trade associations will shortly initiate a global survey of buy- and sell-side firms and of infrastructure providers, regarding their use of IBORs, the extent of their readiness to engage with the transition process across all of their product lines, the issues they foresee and the solutions they may have in mind.
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