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ISDA launches IBOR fallbacks supplement and protocol

The International Swaps and Derivatives Association (ISDA) has launched the IBOR Fallbacks Supplement and IBOR Fallbacks Protocol, marking a step in reducing the systemic impact of a key interbank offered rate (IBOR) becoming unavailable while market participants continue to have exposure to that rate.

The supplement will amend ISDA’s standard definitions for interest rate derivatives to incorporate robust fallbacks for derivatives linked to certain IBORs, with the changes coming into effect on January 25, 2021. From that date, all new cleared and non-cleared derivatives that reference the definitions will include the fallbacks.

The protocol is designed to enable market participants to incorporate the revisions into their legacy non-cleared derivatives trades with other counterparties that choose to adhere to the protocol. The protocol is now open for adherence, and will become effective on the same date as the supplement: January 25, 2021. At launch, 257 derivatives market participants had adhered to the protocol during the two-week pre-launch ‘escrow period’.

Market impact

The fallbacks for a particular currency will apply following a permanent cessation of the IBOR in that currency. For derivatives that reference LIBOR, the fallbacks in the relevant currency would also apply following a determination by the UK Financial Conduct Authority (FCA) that LIBOR in that currency is no longer representative of its underlying market. In each case, the fallbacks will be adjusted versions of the risk-free rates identified in each currency. 

“The implementation of fallbacks for derivatives will go a long way to mitigating the systemic risk that could occur following the disappearance of LIBOR or another key IBOR," said Scott O’Malia, ISDA’s chief executive. "With the fallbacks in place, derivatives market participants will be able get on with transitioning their IBOR exposures with confidence that there is a robust back-up in case of need.”

PwC issued the following response to the ISDA initiative:

“The fallbacks can go a long way in reducing the conduct risk of LIBOR transition for firms," commented Nassim Daneshzadeh, PwC partner. "They are based on extensive consultations involving buy-side and sell-side firms of all sizes. That is exactly the type of market consensus the FCA [Financial Conduct Authority] has called firms to base their transition plans on. Firms have three months to sign-up to the protocol but regulators will expect them to sign-up much earlier than this. They will challenge anyone who leave it to the last minute.”

"Although the vast majority of OTC derivatives are expected to be covered by these fallbacks, some exotic derivatives may be carved out," Daneshzadeh added. "The negotiations between broker-dealers may be long, so we would recommend engaging with counterparties to determine the scope of carve-outs soon. Fallbacks are just one step of the transition. The FCA has compared them to “safety belts” but has called on firms to prioritise active transition of contracts. Market participants will need to keep a close eye on liquidity to determine when active transition would work best for them.”

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