The publication of the ISDA 2020 IBOR Fallbacks Protocol (IBOR Protocol) in October 2020 marked a significant milestone in the IBOR transition. The IBOR Protocol is a critical step in strengthening existing derivative contracts with robust fallback provisions upon the permanent cessation or pre-cessation announcement of a relevant IBOR.
Since publication, global regulators have encouraged market participants to review the terms of the IBOR Protocol and consider adhering. In addition to including the adoption of the IBOR Protocol in its latest Recommended Best Practices, the Alternative Reference Rates Committee (ARRC) also encouraged a subset of derivatives market participants, including major banks and other key market participants, to adhere to the IBOR Protocol “in escrow” (i.e. during the two-week period prior to the publication date). This resulted in the inclusion of major market participants on a list of early adherents announced when the IBOR Protocol officially launched in October and was intended to encourage market participants to follow suit and align with their peers. Similarly, the Financial Conduct Authority (FCA) repeatedly urged market participants from all sectors – sell side, buy side, non-financial — to ensure they are ready for the end of LIBOR by adhering to the IBOR Protocol.
On Monday, ISDA announced the new fallbacks were now in effect for relevant new and existing derivatives and reported more than 12,000 buy and sell-side firms across nearly 80 jurisdictions had adhered to the protocol to date, which will remain open for adherences. We have also noticed a significant increase in the adhering parties over the past week prior to the effective date. Whilst this is unsurprising given human nature – deadlines do typically drive behaviours – it has led some to consider why certain market participants have yet to adhere. Two major considerations for companies could include:
Hedging considerations – The risk free rates (RFR) conventions in loans and derivatives will likely differ. Given this, parties may need to be aware that additional basis risk may arise if there is a mismatch. However, other options exist to reduce or eliminate basis risk such as active transitions to new RFRs or including fallbacks in the loan that will follow the derivative.
Active transitions – Based on the type and volume of LIBOR currently traded and the maturity of these trades, some companies may be considering active transitions to RFRs rather than ‘band-aid’ approaches like the IBOR Protocol. Whilst liquidity in certain RFRs is still limited, this may be a preferable approach for some companies particularly if much of their exposure is in the more commonly traded USD LIBOR tenors (the overnight and one, three, six, and twelve-month) which the IBA has proposed to cease publication from 30 June 2023. Please note, this date remains open to the ICE Benchmark Administration (IBA) consultation process, which closed on Monday.
With this major milestone now behind us, many may be left wondering what’s next for the LIBOR transition. Luckily, it’s anticipated that you won’t have to wait long. With the IBA consultations on the cessation of LIBOR having drawn to a close on Monday, many predict that when the IBA publish the consultation results, they will also use this as an opportunity for a ‘big bang’ cessation timing announcement across all currencies and tenors. In doing so, they would be setting the static fallback spread i.e. five-year historic median ‘snapped’ between LIBOR and compound RFR. The timing for this is, of course, unknown, and will likely depend on the feedback received from the consultation, however if this happens shortly as many expect, it will signify a big start to 2021 for the IBOR transition.