On February 25, 2020, the International Swaps and Derivatives Association (ISDA) launched a new consultation on how to implement pre-cessation fallback language into derivatives agreements.1 Responses are due by no later than March 25th. The consultation’s outcome will be an important step in providing the industry with clarity as the transition away from LIBOR progresses.
ISDA has been exploring pre-cessation fallback provisions since May 2019, when it launched separate consultations for pre-cessation fallbacks and permanent cessation fallbacks.2 ISDA first issued a consultation calling for preferred methods of implementing pre-cessation language into derivatives agreements in response to a letter from the Financial Stability Board Official Sector Steering Group (FSB OSSG) about the potential need for a pre-cessation trigger for fallbacks if LIBOR were deemed by the U.K. Financial Conduct Authority (FCA) to be “no longer capable of being representative” or “non-representative.” While there was support for no longer referencing LIBOR under such circumstances, the responses with respect to implementation were varied and the results were inconclusive.3
In November 2019, the FSB OSSG requested that ISDA adopt pre-cessation language alongside the permanent cessation language that ISDA already had been finalizing through amendments to the 2006 ISDA Definitions and a new “Protocol.” Prior to publication of the new consultation, ISDA sought and received feedback from the FCA, the ICE Benchmark Administration and central counterparties with respect to this matter.4
Implementation of Fallbacks in ISDA Documentation
ISDA intends to amend the 2006 ISDA Definitions by publishing a “Supplement.” The Supplement will contain fallback provisions with respect to the “Rate Options” for LIBOR in each currency in which it is published (USD, GBP, CHF, JPY, EUR) and certain other IBORs. Once the Supplement is published, all transactions that (1) incorporate the 2006 ISDA Definitions, and (2) are entered into on or after the Supplement’s publication will include the amended terms. Counterparties to agreements executed prior to the Supplement’s publication (so-called “legacy” contracts) could opt-in to the updated Definitions, fallbacks and triggers through a Protocol.5 To account for differences between the fallback rates and existing rates, the fallback rates will also be subject to certain adjustments.
Pre-Cessation Proposal: Triggers, Dates and Consequences
Under the proposal, ISDA asks respondents to comment as to whether ISDA should publish a Supplement to the 2006 ISDA Definitions so that the Rate Options for LIBOR in the relevant currencies should contain fallbacks which would apply upon the first of the following to occur: (1) a permanent cessation trigger or (2) a non-representativeness pre-cessation trigger, and publish a Protocol to incorporate the amended definitions into legacy contracts.
If the pre-cessation proposal were implemented and one of the fallback provisions were triggered, the relevant spread adjustment would be calculated as of the triggering event’s announcement date. Accordingly, if the FCA made a “non-representativeness” announcement (i.e., that LIBOR is “no longer capable of being representative”), the relevant spread would be calculated as of the date of that announcement. Alternatively, if LIBOR were deemed permanently discontinued, the relevant spread would be calculated as of the date of that announcement. In either case, the fallback rate would not apply until the date on which LIBOR actually is non-representative or permanently discontinued.
If a non-representativeness announcement occurred before a permanent cessation announcement, or LIBOR’s actual permanent cessation, the non-representativeness spread would be the only spread applicable to derivatives that use standard ISDA Definitions and related Protocol. In other words, the spread for derivatives that use standard ISDA Definitions and related Protocol would not be adjusted to account for a permanent cessation announcement or actual permanent cessation that occurred after a non-representativeness announcement.
Market participants who do not want combined pre-cessation and permanent cessation fallback provisions could bilaterally negotiate terms outside of the standard ISDA Definitions and related Protocol.
ISDA will publish the Supplement and Protocol containing the fallback provisions described above if the following criteria are satisfied:
(1) at least 70 market participants respond with a clear “Yes” or “No” with respect to their support of the proposal;6
(2) at least 35% of responses are from market participants other than banks/broker-dealers and market infrastructure providers;
(3) at least 65% of respondents answer “Yes;”
(4) at least 35% of those who answer “Yes” are not from banks/broker-dealers or market infrastructure providers; and
(5) respondents who select “No” and indicate that they would be unavoidably harmed by and/or unable to use the Supplement and Protocol do not represent a “significant portion” of a particular segment (e.g., all insurance companies).
If the above criteria are not satisfied, ISDA will publish the following instead
(1) the Supplement and Protocol to hardwire permanent cessation fallbacks as planned;
(2) amendments to the 2006 ISDA Definitions (as part of the Supplement) to allow market participants to choose to incorporate the proposed pre-cessation fallbacks alongside the permanent cessation fallbacks into derivatives agreements; and
(3) an “Annex” to the Protocol to allow market participants with legacy contracts to “opt-in” to the proposed pre-cessation fallback provisions with counterparties who also opt-in to those fallback provisions as part of their adherence to the Protocol implementing permanent cessation fallbacks.
ISDA may also publish templates to allow counterparties to legacy contracts to add pre-cessation fallbacks and permanent cessation fallbacks to some, rather than all, of their legacy contracts.
ISDA intends to publish the results of this consultation by late April or early May of this year. Based on those results, ISDA aims to publish final forms of the Supplement and Protocol by Q3 2020.
2. ISDA Publishes Two Consultations on Benchmark Fallbacks, May 16, 2019.
3. Pre-Cessation Consultation Report (May 2019), October 21, 2019.
4. U.K. Financial Conduct Authority Letter Re: LIBOR Non-Representativeness, January 20, 2020; ICE Benchmark Administration Letter Re: LIBOR Non-Representativeness, January 24, 2020; LCH Proposed Changes to the LCH Limited Rulebook, January 27, 2020.
5. The Protocol only binds “adhering parties,” i.e., parties that accept the Protocol’s terms. Adhering parties are also free to negotiate their own fallback terms bilaterally.
6. “Market participants” are (1) banks/broker-dealers; (2) market infrastructure providers (e.g., central counterparties); (3) asset managers; (4) energy/commodity firms; (5) hedge funds; (6) insurance companies; (7) local or regional government entity, supranational or government-sponsored entity; (8) pension funds and (9) other end users (e.g., corporate). Professional services firms and trade associations do not count as market participants. Affiliated entities will be counted as one market participant toward that total and the percentages below.
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