ISDA Chief Says the End is in Sight for IBOR Fallbacks

ISDA chief Scott O’Malia says one year from now, robust fallbacks should be in place for derivatives contracts referencing LIBOR and other IBORs.

Efforts to prepare for the use of RFRs (risk-free rates) as an alternative to LIBOR and other IBORs (interbank offered rates) have been gaining momentum, according to ISDA (International Swaps and Derivatives Association) chief executive Scott O’Malia.

“Awareness of the issue is much greater than it was a year ago, and trading volumes in over-the-counter derivatives linked to RFRs are slowly rising,” he said in a derivatiViews article. “But we also recognise the need for a safety net that will allow derivatives contracts that still reference LIBOR and other IBORs to survive a discontinuation of the underlying benchmark with the minimum possible disruption.”

O’Malia encourages market participants to respond to two new consultations on derivatives fallbacks, which both close on 12 July. These consultations represent another step closer to implementing the “safety net”, he said.

The first consultation set out options for adjustments that will apply to relevant RFRs if fallbacks are triggered for derivatives referencing USD LIBOR, Hong Kong’s HIBOR, and Canada’s CDOR. It also seeks to address fallbacks for Singapore’s SOR, given that USD LIBOR is one of its inputs.

The consultation follows last year’s consultation covering fallbacks for derivatives referencing six other IBORs – GBP LIBOR, CHF LIBOR, JPY LIBOR, TIBOR, Euroyen TIBOR, and BBSW.

According to O’Malia, adjustments to RFRs are necessary because IBORs are available in multiple tenors, but the RFRs are overnight. The IBORs also incorporate a bank credit risk premium and a variety of other factors, while RFRs do not.

“The adjustments are intended to ensure the contracts function as closely as possible to what the counterparties originally intended after a fallback kicks in,” he said. “That doesn’t mean the adjusted RFR will exactly match the relevant IBOR – it won’t, so there will be winners and losers.

“That’s another reason to act early and reduce or eliminate exposure to LIBOR.”

The second new consultation explores pre-cessation issues with respect to how derivatives market participants should address a situation where LIBOR or certain other IBORs are no longer capable of representing an underlying market.

Meanwhile, ISDA is working to flesh out the parameters and mechanics of the term and spread adjustments for fallbacks. In this regard, it plans to release another consultation in August.

It is also planning later this quarter to be able to announce the appointment of an independent service provider tasked with calculating and publishing the term and spread adjustments.

Amended ISDA definitions to implement fallbacks for new contracts referencing IBORs are expected to be ready in Q4. A protocol to allow firms to modify legacy trades to include fallbacks will also be published.

“A lot of progress has been made in the course of a year, but – for fallbacks at least – the end is in sight,” O’Malia said.”One year from now, we should have robust fallbacks in place for derivatives contracts.”

“This will go a long way to easing the systemic implications of a sudden discontinuation of LIBOR and other IBORs.”

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