08.21.2017
By Rob Daly

IBOR Fallbacks Advance

The finish line to find replacement reference rates for the London Interbank Offer Rate and other IBORs finally is in sight.

It may not be close, but it is in sight.

At the end of July, Andrew Bailey, chief executive of the UK’s Financial Conduct Authority announced that his organization would compel panel banks to make LIBOR submissions after the end of 2021.

The Financial Stability Board’s Official Sector Steering Group and the International Swaps and Derivatives Association have been working to identify potential risk-free rates and developing the mechanism to implement such fallbacks into existing and future contracts.

Various OSSG working groups have either identified likely candidates to step in if LIBOR or other key IBORs are permanently or indefinitely discontinued.

The Bank of England announced in April that it selected a reformed version of SONIA as its preferred risk-free interest rate benchmark. The Federal Reserve Bank of New York-sponsored Alternative Reference Rate Committee has elected to use a Broad Treasuries Repo Financing Rate. The study group examining alternatives to yen/LIBOR and yen/TIBOR has picked TONA as its reference rate candidate. The OSSG working group responsible for finding a replacement for the CHF/LIBOR rate is leaning towards SARON reportedly.

“These groups are currently developing plans for the transition from IBOR to these identified rates,” said Ann Battle, assistant general counsel at ISDA, during a recent webcast. “In the case of LIBOR, that work has been more of a focus now that has more of a time horizon.”

While the OSSG working groups have been identifying their candidates, ISDA has been working on how to implement the fallback mechanism once all the alternative benchmark rates have been selected.

The industry body has divided its work among four working groups. Three of the working groups focus on the requirements for the dollar/LIBOR, sterling/LIBOR, and yen/LIBOR while the fourth is working on the same issues for the Australian dollar, Hong Kong dollar, and Singapore dollar.

The working groups look to harmonize and coordinate the fallback mechanism, according to Battle. “Of course, they are taking into account their regional differences in IBORs and the fallback rates available for those currencies,” she added.

To help frame the necessary processes, ISDA has developed a working definition for when an IBOR is permanently or indefinitely discontinued and a fallback needs to be activated. The trigger would be when the IBOR administrator is insolvent, and there is not an immediate successor administrator.The fallback would happen when the IBOR administrator or the administrator’s supervisor makes a public statement announcing that its IBOR has been discontinued immediately or at some future date.

“The fallback would apply at the first date when after the IBOR is permanently discontinued not the date of the announcement,” noted Battle. “The idea that these fallbacks would kick in immediately after the contract can no longer reference the relative IBOR.”

However, ISDA’s working groups are still working on the fallback mechanism as the risk-free rates are overnight rates that lack an IBOR’s terms structure.

“Those are key issues that need to be worked out,” said Battle. “You would work those out on an ex-ante basis and would write in whatever methodology is used to address those issues into the actual contract.”

The sub-group on spreads looks to develop a model that would handle the transition that would minimize any possible value transfer during the fallback’s activation as well the potential for market manipulation. The group also would like make sure that markets can continue relatively stress-free and undistorted during a fallback activation as well as have any calculation involved transparent and easy for market participants to replicate.

Although the subgroup has reached a consensus on its priorities, they may change with further consultation with the industry, according to a member of the sub-group.

ISDA still needs to select which of many available models to use and whether the model re-prices its inputs exactly or constrains the term structure in some manner.

Once ISDA makes its final choice, it plans to implement a reference to the fallback mechanism by amending the ISDA 2006 definitions so that any contract agreed to on the date of the amendment or after would reference the appropriate IBOR as well as the fallback mechanism.

Legacy contracts would require those who entered into those contracts to amend the contracts themselves, according to Battle.

ISDA is looking to develop a protocol to facilitate multi-lateral amendments that would allow parties to adhere to amendments and agree to every other party that adheres to the amendments, which would be deemed made.

“Once we get through the first two steps, it is something that we are considering doing to enable the market to efficiently implement these fallbacks,” said Battle.

If these amendments are made, they will not change the actual rates referenced in the individual contract, she added. “Any contract amended in this way would still be LIBOR, Euribor, or TIBOR contracts. They just would be contracts that would reference those rates with a fallback.”

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