New Isda ‘fallbacks’ critical to making Libor transition a ‘non-event’

Much of the transition of approximately $350 trillion of financial derivatives contracts away from references to the scandal-hit London interbank offered rate is expected to be completed by the end of 2021. If this transition takes place without too much furore, it will be in large part due to the publication of the International Swaps and Derivatives Association’s (Isda’s) Ibor Fallbacks Supplement (to its 2006 Definitions) and Ibor Fallbacks Protocol in October.

These new fallback arrangements, made in response to a request from the Financial Stability Board, provide a vital means to facilitate a smooth transition from the use of Libor to more specifically appropriate reference marking prices for swaps and other financial contracts. 

The demise of Libor and the need to define and use new reference rates are well documented. One need arises because Libor is not expected to be published after 2021 (at least the UK’s Financial Conduct Authority (FCA) will not compel banks to submit Libor references). Another requirement is that Libor in its present form does not effectively track the value of, say, a swap denominated in Swiss francs, among contracts denominated in many other currencies.

On the timing of the transition mechanism, Isda states: “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 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.” 

Central banks, national authorities and industry groups have worked to define, at a minimum, new ‘Ibors’ for US dollar, sterling, Swiss franc, yen in several forms, a variety of euro (including offshore) currencies, Canadian dollar, Hong Kong dollar and Australian dollar. Even so, the expected cessation may not be complete by the end of 2021. Notably, based on a statement by the US Federal Reserve Board of November 30, only US dollar one-week and two-month Libor are now proposed to be retired at the end of 2021, while the other US dollar Libor tenors are now proposed to be published until June 2023.

The migration away from using the legacy Libor may have been obscured somewhat by the major distractions of 2020. But it cannot be ignored any longer

Richard Heckinger

Isda has responded to this announcement as follows, “None of these statements constitute an index cessation event under the Ibor Fallbacks Supplement or the Isda 2020 Ibor Fallbacks Protocol. Therefore, these statements will not trigger the fallbacks under the supplement or protocol (ie, to the adjusted risk-free rate plus spread) or have any effect on the calculation of the spread. These statements will also not trigger fallbacks under the 2018 Isda Benchmarks Supplement or its protocol.” So, parties to swaps need to be up to date with the latest news because details are still evolving.

The migration away from using the legacy Libor may have been obscured somewhat by the major distractions of 2020. But it cannot be ignored any longer. Fortunately, after much consultation and work on the various case possibilities the fallbacks are available along with considerable education and evaluation information supplied by Isda to help all parties to swaps contracts deal with amending their contracts.

The FSB had requested Isda to pursue work to strengthen Ibor fallbacks. The fallbacks now provide well-defined means to alter swaps agreements efficiently, and to process a change to a new Ibor. The protocol can be adopted now, and the supplement can be implemented from January 25, 2021.

Of course, it is hoped that the swaps participants will pro-actively amend their contracts before the event of cessation of an Ibor or a determination of non-representativeness announcement. There has been progress at least in the adoption of the protocol. Isda reports that over 1,300 legal entities have adopted the protocol, although the US Commodity Futures Trading Commission (CFTC) estimates that 2,400 corporate groups have exposure to swaps that reference Libor but have not yet adopted the protocol.  Regardless of the large scale and wide scope of the efforts necessary to achieve smooth transitions to the new Ibors, Isda’s publication of the supplement and protocol provides the swaps community with the key tools it needs to make the migrations to the new Ibors hopefully one of the biggest non-events of 2021.