ISDA Gets DoJ, FSB, Nod on Fallbacks

The International Swaps and Derivatives Association’s (ISDA) proposal on a Fallback Protocol to ease the transition from Ibors to new Risk Free Rates (RFRs) has overcome a big hurdle with the US Department of Justice stating it has no objections to ISDA’s suggested pathway.

In a business review letter the DoJ says it has concluded that “ISDA’s proposal is unlikely to produce anticompetitive effects, and ISDA’s proposal has the potential to offer substantial benefits to the financial services industry. Accordingly, the Department has no present intention to challenge ISDA’s proposal to amend its standard documentation”.

The US is the only major jurisdiction with a formal approval process, however ISDA has said it has remained in touch with other authorities around the world and has kept them “fully informed“. Thus, ISDA says, it does not anticipate adverse action by these authorities with respect to its implementation of new fallbacks in ISDA’s standard documentation for derivatives.

As a result of the approval, ISDA will formally launch the Ibor Fallbacks Supplement to the 2006 ISDA Definitions and the ISDA 2020 Ibor Fallbacks Protocol on October 23, 2020.

The supplement and the amendments made by the protocol will take effect on January 25, 2021. On this date, all new derivatives contracts that incorporate the 2006 ISDA Definitions and reference one of the covered Ibors will contain the new fallbacks. Derivatives contracts existing as of this date will incorporate the new fallbacks if both counterparties have adhered to the Protocol or otherwise bilaterally agreed to include the new fallbacks in their contracts. The Protocol will remain open for adherence after this effective date.

The development has been welcomed by the Financial Stability Board (FSB), which has released a statement “strongly encouraging widespread and early adherence to the protocol”, adding that the protocol “will be a major driver of transition for derivatives in all Libor currencies and a critical step in benchmark transition ahead of end-2021”.

Reiterating its view that Libor transition is a G20 priority, FSB says, “Firms across all jurisdictions should continue their efforts to reduce reliance on ibors where appropriate and, in particular, remove remaining dependencies on Libor by the end of 2021. As part of this, market disruption in such an event the fallback arrangements that would apply if a permanent discontinuation of an Ibor or other interest rate benchmark occurred, and to ensure these arrangements are robust enough to prevent potentially serious market disruption in such an event. The Protocol and ISDA fallback language will create a readily available avenue to adopt fallbacks into most derivatives contracts and replace Ibor exposures with risk-free rate linked alternatives, once fallbacks have been triggered.”

The FSB adds that its Official Sector Steering Group (OSSG) has engaged regularly with ISDA during the significant programme of work that it has undertaken since July 2016 to strengthen the robustness of derivatives markets as part of global benchmark reforms. It states, “The FSB encourages adherence to the Protocol as a tangible step that can be taken by both financial and non-financial firms to avoid disruptions in covered derivatives contracts if the Ibor they currently reference is discontinued or, in the case of Libor, becomes non-representative. Widespread adoption of the Protocol will be necessary to ensure it is effective in mitigating risks at a system-wide level. Any market participants who choose not to do so for some or all of their relevant trades will need to take robust alternative steps, such as closing out these positions or appropriate bilateral amendments, to avoid the risk of disruption.”

Andrew Bailey, governor of the Bank of England and co-chair of the OSSG, says, “Finalisation of the ISDA Protocol is an important step in addressing the stock of legacy Libor-linked contracts ahead of end-2021. I would like to thank ISDA for its work on ensuring markets now have a robust and trusted fallback for trillions of dollars of derivative contracts.”

Bailey’s co-chair, John Williams, president of the Federal Reserve Bank of New York Fed, adds, “ISDA’s Protocol is another important milestone in the movement off of Libor. It’s vitally important that firms quickly sign onto the Protocol to ensure that existing derivatives contracts are equipped with strong fallbacks.”

Colin Lambert

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