Following many months of consultation, on January 25, 2021, Supplement number 70 to the 2006 ISDA Definitions (the Supplement)1will take effect and amend the 2006 ISDA Definitions such that all transactions incorporating these definitions that are entered into on or after this date will incorporate the new IBOR fallbacks, unless the parties specifically exclude them. Additionally, the ISDA IBOR Fallbacks Protocol (the Protocol)2will also become effective, enabling adhering parties to incorporate the new IBOR fallbacks into existing (legacy) derivatives agreements.3The effectiveness of these documents marks a crucial step in the LIBOR transition, as they facilitate the multilateral amendment of legacy derivatives agreements without requiring renegotiation on a transaction-by-transaction basis and the adoption of fallback language into new derivatives agreements.
In 2017, the U.K. Financial Conduct Authority (FCA) announced that it will no longer compel banks to make LIBOR submissions after the end of 2021.4 More recently, ICE Benchmark Administration (IBA) published a consultation on ceasing publication of one-week and two-month USD LIBOR settings at the end of December 2021 and ceasing publication of the remaining overnight and one-, three-, six- and 12-month USD LIBOR settings at the end of June 2023. The FCA and multiple other official sector entities have expressed support for this proposed timing and provided related guidance.5 Over $350 trillion of various financial instruments currently reference LIBOR,6 many of which do not have adequate fallback language to address its permanent discontinuation. Industry working groups in the LIBOR jurisdictions have since developed recommended alternative risk-free fallback rates to LIBOR. To address the inadequacy of the current ISDA definitions language to deal with permanent discontinuation of LIBOR, ISDA issued several industry-wide consultations on questions relating to appropriate adjustments to risk-free rate alternatives to IBORs, fallback triggers and general fallback language which were used to develop the Protocol and Supplement.7While adherence to the Protocol will be voluntary, it has been encouraged by regulators as an important step in the LIBOR transition.8
Overview of Protocol and Supplement
The Protocol and Supplement amend the definitions of certain "rate options" by providing fallbacks that would apply upon the permanent discontinuation of key interbank offered rates (IBORs) and the non-representativeness of LIBOR rates.
The Supplement updates the rate options set out in the 2006 ISDA Definitions. New derivative contracts incorporating the 2006 ISDA Definitions from January 25, 2021 onwards will automatically incorporate the 2006 ISDA Definitions as amended by the Supplement.
The Protocol enables parties to incorporate the terms of the Supplement in their existing "Protocol Covered Documents." The amendments will be effective on the later of January 25, 2021 or the Protocol adherence date of the counterparty which adheres to the Protocol latest.
A Protocol Covered Document includes the following documents dated before the effectiveness of the Protocol between two counterparties (i) incorporating the 2006 ISDA Definitions or certain earlier ISDA definitions (i.e., the 2000 ISDA Definitions, the 1998 ISDA Euro Definitions, the 1998 Supplement to the 1991 ISDA Definitions or the 1991 ISDA Definitions) incorporating the relevant rate options (each a Covered Definition Booklet), (ii) referencing an IBOR "as defined" in or with the meaning given in a Covered ISDA Definitions Booklet or (iii) referencing an IBOR howsoever defined:
- ISDA Master Agreements or certain other forms of master agreements, including certain master repurchase agreements and securities lending agreements (Master Agreements) and confirmations that supplement or are otherwise governed by such master agreements; and
- certain credit support documents, including certain collateral annexes and credit support appendices.9
The Protocol and Supplement provide fallbacks to risk-free rates which are adjusted to account for the difference in term and credit risk between the IBORs, which represent unsecured interbank term lending rates, and the RFRs, which are overnight risk-free rates. ISDA selected Bloomberg Index Service Limited to calculate and publish the adjustments to the RFRs and the 'all-in' fallback rate.10
Specifically, on a daily basis, Bloomberg calculates and publishes the following for a range of tenors for each IBOR on an indicative basis as if the trigger event were to occur on that particular day:
- Term-adjusted RFR: the RFR observed over a period (generally equivalent to the IBOR tenor), compounded daily and backward-shifted (so the rate is known prior to the payment date);
- Spread adjustment: an adjustment equal to the median of the differences between the IBOR and the compounded RFR for the relevant tenor calculated over a static lookback period of five years prior to the earlier of the date of the permanent cessation trigger or pre-cessation trigger;11 and
- The 'all-in' fallback rate: the sum of the term-adjusted RFR and the spread adjustment.
Bloomberg began publishing indicative fallback data on July 17, 2020. Details with respect to its calculation methodology are provided in Bloomberg's IBOR Fallback Rate Adjustments Rule Book.12
Pursuant to the Supplement and Protocol, a fallback rate would be triggered upon an "Index Cessation Event" which would be one of the following events:
- A permanent cessation event
which would be one of the following:
- a public statement by or on behalf of the administrator of the relevant IBOR announcing that it has ceased or will cease to provide the relevant IBOR permanently or indefinitely, provided that, at the time of the statement, there is no successor administrator that will continue to provide the relevant IBOR; or
- a public statement by the regulatory supervisor for the administrator of the relevant IBOR, the central bank for the currency of the relevant IBOR or an insolvency official, resolution authority or similar entity with jurisdiction over the administrator for the relevant IBOR, which states that the administrator of the relevant IBOR has ceased or will cease to provide the relevant IBOR permanently or indefinitely, provided that, at the time of the statement or publication, there is no successor administrator that will continue to provide the relevant IBOR.
- With respect to LIBOR only, a pre-cessation event, which would be a public statement by the regulatory supervisor for the administrator of the relevant IBOR announcing (A) that the relevant IBOR is no longer, or as of a specified future date will no longer be, capable of being representative of the underlying market and economic reality that the relevant IBOR is intended to measure as required by applicable law or regulation and (B) that the intention of that statement or publication is to engage contractual triggers.
The spread adjustment applicable to a particular IBOR will be fixed upon the announcement date of an Index Cessation Event.
In lieu of triggering a fallback rate, if not all tenors permanently cease or, in the case of LIBOR, become non-representative, and the rate administrator continues to publish at least one shorter and one longer tenor and, in the case of LIBOR, these tenors are not non-representative, the reference rate would be alternatively determined by interpolating the nearest remaining shorter rate and nearest remaining longer rate.
Adherence to the Protocol
There is currently no cutoff date for adherence to the Protocol, although ISDA reserves the right to designate a closing date by giving at least 30 days' notice. There is a fee of $500 for ISDA Primary Members to adhere. There is no fee for non-ISDA Primary Members to adhere prior to January 25, 2021 and a one-time $500 fee to adhere at a later date.
To adhere to the Protocol, market participants can go to the Protocols section of the ISDA website to generate and sign the form of adherence letter. The PDF can then be uploaded into the Protocol system. Once ISDA has accepted the adherence letter, it will send an email confirmation of adherence to the adhering party. Agents may adhere to the Protocol on behalf of their clients.
Potential Issues with Opting Out of Protocol Adherence
As noted, adherence to the Protocol is voluntary, but choosing not to adhere is not without risk. To date, more than 2000 parties have chosen to adhere to the Protocol. Below are set out some potential issues that entities should be aware of should they choose to opt out of adherence.
Lack of Existing Viable Fallbacks
Legacy derivatives contracts that do not incorporate the new fallbacks will typically include a fallback to quotations from reference banks. These fallbacks specify that the calculation agent will request quotations from reference banks, but do not set out further fallbacks if such quotations are not available. In the event of a permanent cessation of a rate, these fallbacks likely will not provide a robust or sustainable outcome.
Mismatches with New Contracts
Unless the new fallbacks set out in the Supplement are specifically excluded by parties in new contracts, they will be included in all new transactions incorporating the 2006 ISDA Definitions that are entered into on or after January 25, 2021. If the new fallbacks are not also applied to legacy derivatives contracts (either via the Protocol or bilaterally), then there may be a mismatch between the fallbacks that apply to an entity's legacy derivatives portfolio and those that apply to more recently executed derivatives contracts.
Mismatches with Cleared Contracts
Central counterparties have generally updated or will generally update their rulebooks to include the new triggers and fallbacks in new and existing cleared derivatives. Entities should consider potential mismatches between non-cleared and cleared derivatives if they choose not to adhere to the Protocol or adopt the new fallbacks bilaterally.
Potential Issues with Adhering to the Protocol
While adhering to the Protocol provides an efficient mechanism to address the lack of effective fallbacks in legacy derivatives contracts, adherence may also carry potential risks that entities should understand in advance of adherence.
Mismatches with Hedged Contracts
If a derivative is used to hedge an underlying instrument, such as a loan or a bond, it is important to understand the triggers and fallbacks in both the underlying instrument and the derivative to know whether they match or diverge and, if they diverge, whether the differences are minor or material. If material, parties should consider whether the associated risks can be managed – for example, by entering into a further hedge. Parties may alternatively decide that they would prefer the triggers and fallbacks for their hedge to match the triggers and fallbacks for the underlying instrument, in which case a separate amendment may be needed for that hedge.
Implementing the fallbacks into non-linear derivatives products, such as swaptions and others, may require additional analysis to understand how the fallbacks work in such products and whether it is appropriate to directly incorporate or modify the fallbacks. ISDA has published a Product Table13 that explains the effect of the fallbacks upon various non-linear products and potential related considerations. ISDA has, in particular, noted that, for certain products, parties may wish to amend certain defined terms relating to dates used in the Protocol to better align with these products.
Third Party Consents
The Protocol includes an undertaking that where any applicable third-party credit support document requires the consent of that third party to be obtained, before any amendment is made, such consent has been obtained. Parties should therefore consider whether any such consents are required before adhering to the Protocol.
Additional Steps to Reconfirm or Retake Security
Parties to any credit support document amended by the Protocol should consider whether they need to take steps to reconfirm or retake any security or otherwise satisfy any formalities under or in connection with such document as a result of an amendment made by the Protocol.
Entities should also consider possible tax and accounting implications of adherence.
As an alternative to Protocol adherence and to address some of the potential concerns discussed above, ISDA has published a number of templates containing provisions to bilaterally incorporate the Protocol amendments in a more flexible manner. Below are the distinguishing features of each template:
- Template 1 - Short-form bilateral amendment agreement – this agreement enables parties to amend one or more of their existing documents to incorporate by reference the terms of the Protocol and to include additional terms, including from the other templates published separately by ISDA, to supplement or to amend its scope.
- Template 2 - Long-form bilateral amendment agreement – this agreement enables parties to amend one or more of their existing documents to incorporate the relevant terms of Protocol, tailored as appropriate, and to add further terms, including from other templates.
- Template 3 - Template language for excluding agreements – this template language excludes certain agreements or transactions from the Protocol amendments and contains bespoke fallbacks instead.
- Template 4 - Template language for adding agreements – this language incorporates additional existing documents into the scope of the Protocol.
- Template 5 - Template language for disapplying fallbacks – this language disapplies the pre-cessation LIBOR fallbacks.
- Template 6 - Framework for amendment agreement – this template language enables parties who have adhered to the Protocol to amend its scope and terms in relation to one or more existing Protocol Covered Documents by including language from the other templates.14
Further Guidance on the Application of the Protocol and Supplement
Since the publication of the Supplement and Protocol, in connection with certain announcements relating to IBOR cessations, ISDA provided practical guidance clarifying whether the fallbacks set out in the Protocol and Supplement were triggered and explaining how the ISDA fallbacks apply upon the announcement of an IBOR cessation.15
Refinitiv Announcement of the Cessation of the 6-Month and 12-Month Canadian Dollar Offered Rate
On November 12, 2020, Refinitiv Benchmark Services (U.K.) Limited announced that it will cease publication of the 6-month and 12-month Canadian Dollar Offered Rate (CDOR) tenors from Monday May 17, 2021 onwards and that the last day of publication for these tenors will be Friday May 14, 2021. Publication of the 1-month, 2-month and 3-month tenors will continue.16
ISDA applied the Protocol and Supplement language to the cessation announcement and determined that because there will be no successor administrator for the 6-month and 12-month CDOR tenors, and there will be no longer CDOR tenor that would allow for linear interpolation, an Index Cessation Event with respect to the rate options associated with the 6-month and 12-month CDOR tenors (i.e., the 6- and 12-month CAD-BA-CDOR Rate Option and the CAD-BA-CDOR-Bloomberg Rate Option) is deemed to have occurred on November 12, 2020. The related Index Cessation Effective Date will occur for these rate options on May 17, 2021, which is the first date on which no longer tenor will be published and on which the fallback rate (CORRA) will apply. ISDA also noted that future events could arise that may affect the timing an application of the fallback rate, such as a subsequent Index Cessation Event announcing that the 6- and 12-month CDOR tenors may cease to be provided from a different date, which would change the Index Cessation Effective Date accordingly.
Bloomberg confirmed that under the Bloomberg IBOR Fallback Rate Adjustments Rule Book, the announcement will constitute a "Tenor Cessation Trigger Date" which means that the spread adjustment for the 6-month and 12-month CDOR tenors was fixed on November 12, 2020.
ICE Benchmark Administration Announcements on Its Intention to Consult on the Cessation of Certain LIBOR Settings
In November 2020, IBA announced its intention to consult on the cessation of: (i) euro, sterling, Swiss franc and yen LIBOR after December 31, 2021; (ii) one-week and two-month USD LIBOR settings immediately following the LIBOR publication on December 31, 2021; and (iii) overnight and one-, three-, six- and twelve-month USD LIBOR settings immediately following the LIBOR publication on June 30, 2023. In connection with these announcements, and related announcements by the FCA setting out its potential approach to its proposed new powers under the U.K. Financial Services Bill to prohibit some or all new use of a critical benchmark by U.K. supervised entities where the administrator has announced that the benchmark will cease, ISDA released statements clarifying that none of these statements constituted index cessation events under the Protocol or Supplement. Therefore, the announcements will not trigger the fallbacks under the Supplement or Protocol and did not have any effect on the calculation of the spread adjustment.17
1. ISDA, Amendments to the 2006 ISDA Definitions to include new IBOR fallbacks, Supplement number 70 to the 2006 ISDA Definitions (October 23, 2020).
2. ISDA, ISDA 2020 IBOR Fallbacks Protocol (October 23, 2020).
3. ISDA, ISDA Launches IBOR Fallbacks Supplement and Protocol (October 23, 2020).
4. The recent ICE Benchmark Administration consultation regarding extending the cessation of the Overnight, 1-, 3-, 6- and 12-Month USD LIBOR settings until June 30, 2023 and related regulatory response suggests that a different approach may be taken with respect to certain USD LIBOR tenors; however, regulators are still encouraging market participants to transition away from LIBOR as soon as practicable. IBA, ICE LIBOR® Consultation on Potential Cessation (December 2020). Financial Conduct Authority, FCA Response to IBA's Proposed Consultation on Intention to Cease US$ LIBOR (Nov. 30, 2020).
5. Intercontinental Exchange, Inc., ICE Benchmark Administration to Consult on Its Intention to Cease the Publication of One Week and Two Month USD LIBOR Settings at End-December 2021, and the Remaining USD LIBOR Settings at End-June 2023 (Nov. 30, 2020).
6. Bloomberg Professional Services, Fact Sheet IBOR Fallbacks (September 29, 2020).
7. See, e.g., ISDA Pre-Cessation Consultation Results, May 14, 2020; ISDA Spread and Term Adjustments Consultation, November 15, 2019.
8. Federal Reserve, ISDA IBOR Fallback Protocol and IBOR Fallback Supplement (October 9, 2020); Speech by Edwin Schooling Latter, Director Markets and Wholesale Policy at the FCA, LIBOR transition - the critical tasks ahead of us in the second half of 2020 (March 8, 2020).
9. The Additional Documents Annex to the Protocol sets out specific additional master agreements and credit support documents to which the Protocol applies.
10. Bloomberg Professional Services, Fact Sheet IBOR Fallbacks (September 29, 2020).
11. The adjustment is fixed upon the announcement of a permanent cessation trigger or, in the case of LIBOR, a pre-cessation.
12. Bloomberg Professional Services, IBOR Fallback Rate Adjustments Rule Book.
13. ISDA, RFR Conventions and IBOR Fallbacks - Product Table (Sept. 28, 2020).
14. ISDA, Outline of Bilateral Forms for IBOR Fallbacks.
15. ISDA, Tenor Cessation Guidance - 2006 ISDA Definitions; Refinitiv announcement of permanent cessation of 6-month and 12-month CDOR tenors (November 17, 2020).
16. Refinitiv Benchmark Services (U.K.) Limited, Announcement Following Public Consultation; 6-Month and 12-Month Tenor Cessation; Contribution Window Amendment (November 12, 2020).
17. International Swaps and Derivatives Association, ISDA Statement on IBA, U.K. FCA and Federal Reserve Board Announcements on U.S. Dollar LIBOR Consultation (Nov. 30, 2020), available at https://www.isda.org/2020/11/30/isda-statement-on-iba-uk-fca-and-federal-reserve-boardannouncements-on-us-dollar-libor-consultation/; International Swaps and Derivatives Association, ISDA Statement on IBA and UK FCA Announcements on LIBOR Consultations (November 18, 2020); Intercontinental Exchange, Inc., ICE Benchmark Administration to Consult on Its Intention to Cease the Publication of One Week and Two Month USD LIBOR Settings at End-December 2021, and the Remaining USD LIBOR Settings at End-June 2023 (Nov. 30, 2020); Intercontinental Exchange, Inc., ICE Benchmark Administration to Consult On Its Intention to Cease the Publication of GBP, EUR, CHF and JPY LIBOR (Nov. 18, 2020).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.