A key landmark in IBOR transition

ISDA IBOR Fallbacks Supplement and Protocol go live 5 min read

The long-awaited ISDA IBOR Fallbacks Supplement and Protocol will be going live today with the endorsement of ASIC, the RBA and APRA.

They implement new benchmark fallbacks for both future and existing derivative contracts, facilitating the efficient transition from LIBOR and other IBORs in anticipation of their discontinuation.

If you have a derivatives portfolio, the Protocol allows quick and easy adoption of the new fallbacks through a one-off adherence. That said, it may not be sufficient to cover all scenarios.

LIBOR is expected to be discontinued at the end of 2021. As a result there is commercial imperative and regulatory pressure to transition away from its use.
The Supplement provides for new fallbacks of benchmark rates, including LIBOR and BBSW. If you have a derivatives portfolio, the Protocol allows quick and easy adoption of the new fallbacks through a one-off adherence. That said, it may not be sufficient to cover all scenarios.
IBOR transition is a complex project which may well affect many aspects of a business. Make sure you have a bespoke strategy to facilitate a targeted and efficient LIBOR transition.

Who in your organisation needs to know about this?

Users of derivatives, corporate treasurers, benchmark transition project team, legal counsel and compliance.

What are the ISDA IBOR fallbacks documents?

The Supplement

For contracts entered into on or after 25 January 2021, the Supplement will automatically apply if the 2016 ISDA Definitions are incorporated in the contract. The Supplement amends benchmark definitions contained in the 2006 ISDA Definitions to provide fallbacks for them. These fallbacks reflect new market conventions which are the result of a number of consultations conducted over the last 18 months.

The new fallbacks waterfalls are triggered in the event of a permanent cessation of the relevant IBOR and, in the case of LIBOR, also in the event of a ‘pre-cessation’ event (ie fallbacks to LIBOR begin to apply not only when LIBOR has actually permanently ceased being published, but also if someone like the administrator of LIBOR or Bank of England says it is no longer reflective of the underlying market).

The new fallbacks provide:

first, in event of a temporary non-publication, for determination by the Calculation Agent;
second, in the event of a cessation or pre-cessation event occurring, for the relevant risk-free rate plus a spread adjustment to apply; and
third, further fallbacks should that also fail.

The Protocol

For contracts entered into before 25 January 2021, adherence to the Protocol by both counterparties to a contract automatically amends the contract to incorporate the new fallbacks. Covered contracts will automatically be amended on the later of 25 January 2021 or the date on which the later of the two parties adheres to the Protocol. This replaces the need for lengthy and costly multiple bilateral negotiations. Parties need only adhere to the Protocol once.

The Protocol is deliberately broad and flexible. It allows amendment of contracts incorporating ISDA Definitions other than the 2006 ISDA Definitions and even of certain non-ISDA documents. It also applies to a wide range of IBORs, including BBSW, for which the fallbacks are provided as a longer-term contingency.

Starting from today, market participants are able to adhere to the Protocol.

Bilateral Agreements

In case a participant's counterparty has not adhered to the Protocol, the pro forma Bilateral Amendment documents provide a form of contract for parties to amend the relevant contracts on a bilateral basis. The template bilateral agreements also enable participants to tailor the scope of the Protocol's application by:

including or excluding documents from the Protocol's application;
excluding documents from the Protocol's application and amending the documents so that the fallbacks match those in related hedged products; and
disapplying the pre-cessation-cessation trigger for LIBOR.

Why is this a landmark in IBOR Transition?

For the derivatives market these settled fallbacks provide a level of certainty. A vast proportion of all LIBOR linked products are derivatives. So it is vital from a systemic and regulatory perspective that the trillions of dollars of derivative contracts have robust fallback waterfall. This is a key reason why it has been universally welcomed by regulators and industry bodies around the world including our local Australian regulators ASIC, the RBA and APRA who have issued a joint statement recommending derivatives market participants adhere to the Protocol.
For non-derivative markets, this launch is widely expected to serve as a catalyst for the acceleration of IBOR transition generally. Significant discussions between ISDA and other industry bodies who are in the process of establishing their own market conventions mean that the publication of these new fallback conventions will likely have an impact on the development of fallbacks for non-derivative products, particularly those which are derivative-linked.

Transition strategy: not a one size fits all

It is clear that ISDA's publication of the IBOR fallbacks documents is an important moment, and adherence to the Protocol helps facilitate a uniform and market-wide approach in the transition of legacy trades. However, it should be remembered that in specific cases adherence alone may not be enough, particularly in relation to linked derivative transactions such as hedged loans where regard must be had to the linked product to avoid a mismatch of basis and more complex non-linear derivatives (eg swaptions, caps and floors). With regard to the latter, we expect ISDA will be publishing further information on how they would function on application of the new fallbacks.

More generally, given the complexity of the LIBOR transition project and its wide-reaching effect on various aspects of a participant's business, it is important for participants to adopt a bespoke transition strategy to minimise potential conduct risk and efficiently facilitate the transition.

For specific questions or further information

Please get in touch with the Allens expert team to learn more about how we can assist with your benchmark transition project or any other questions in relation to derivatives more generally.
For more information, watch our video from the FX Markets Australia Virtual Conference panel on Overview on Benchmark Reforms, in which Yu Zhang is a panellist, which discusses broader issues to do with benchmark reforms, including regulatory conduct risk and tough legacy transactions.
Our colleagues at Linklaters London have acted as counsel for ISDA on these consultations and in drafting these fallback documents. For more information on this, please see this factsheet released by Linklaters, ISDA and Bloomberg.