On February 5, the International Swaps and Derivatives Association (“ISDA“) announced that it will seek additional information from market participants about the development of contractual language that can be used to replace references to LIBOR and other interbank offered rates in swaps and other the over-the-counter (“OTC“) derivative contracts.  ISDA refers to this replacement contractual language as “fallback language”.

On February 6, ISDA provided an updated timeline that relates to the development and implementation of this fallback language.  Also, ISDA confirmed that buy-side firms will not be charged a fee, if they adhere to the final fallback protocol within three months of its publication.

This post will provide additional information about these two developments.

In our experience, many clients find LIBOR replacement discussions and planning to be confusing and somewhat stressful (as is often the case with very significant, market-wide events that, usually by necessity, develop over the course of several years in a “hurry up and wait” manner).

In an attempt to “cut through” some of the confusion, we have prepared a “bullet point style” post that summarizes the February 5th and 6th announcements from ISDA.  Apologies in advance to any legal writing purists.

  • The “Permanent Cessation” of LIBOR – As widely reported, the administrator of LIBOR and other interbank offered rates will stop publishing these rates at the end of 2021.  The occurrence of this event is frequently referred to as the “permanent cessation” of LIBOR.
  • “Pre-Cessation” Concerns –  Many market participants have expressed concerns about the operation of the derivatives markets during the period of time prior to the permanent cessation of LIBOR, if the U.K. Financial Conduct Authority (the “FCA“) announces that the then-current LIBOR is no longer representative of the underlying market.  The period of time prior to the permanent cessation of LIBOR (or, similarly, any other interbank offered rate (“IBOR”)) during which there is a non-representative published rate is frequently referred to as the “pre-cessation” period.
  • ISDA’s Development of Fallback Language – ISDA is working diligently to develop pre-cessation and permanent cessation fallback language.  One of the key issues that ISDA is dealing with the relationship between pre-cessation fallback language and the permanent cessation fallback language – specifically, ISDA is considering one of two approaches that we refer to as the “Linked (or ‘Atomic’) Approach” and the “Elective Approach“.
    • The Linked (or “Atomic”) Approach – Under the first approach, the pre-cessation fallbacks would be linked with permanent cessation fallbacks as the standard “documentation patch” to the 2006 ISDA Definitions.  As explained by ISDA, “If there is sufficient support [from market participants] for this approach , it would mean a fallback would take effect if an [IBOR] ceases to exist or a regulator announces it is no longer representative of the underlying market, whichever comes first.” (Emphasis added.)  In other words, if two counterparties adhere to the fallback protocol that ISDA eventually publishes, then the fallback to the alternative reference rate will happen atomically by operation of that protocol.
    • The Elective Approach – Under the second approach, the counterparties to a swap or other OTC derivative contract governed by ISDA-published documentation will need to elect for the pre-cessation fallbacks to apply to their transaction(s).  The permanent cessation fallback language would apply without election.
  • The February 5th Announcement from ISDA – On February 5th, ISDA announced that it is going to consult with market participants about the differing approaches to the operation of pre-cessation fallback language.  This consultation will be the second time that ISDA has consulted with market participants about pre-cessation planning issues.  There was no consensus with respect to pre-cessation planning issues under the first consultation, which took place during the period from May to June 2019.
    • Why Is A Second Consultation on Pre-Cessation Issues Necessary? – Because new information is available to the market from the LIBOR regulator and administrator, as well as a central counterparty that clears swaps that reference LIBOR.  These developments are discussed in greater detail in ISDA’s February 5th publication, Another Look At Pre-cessation, which is available here.
    • When Will The “Re-Consultation” Occur? – The second pre-cessation consultation will occur later in February 2020.
    • What Will Happen If There is Not Sufficient Support for the Linked Approach? – ISDA has indicated that the Elective Approach will be used, if there is not sufficient support for the Linked Approach in connection with this recently announced consultation. As of this point in time, there is no further quantitative metric in regard to what constitutes “sufficient support”.
  • The Updated Timeline for LIBOR-Fallback Implementation – On February 6, ISDA provided the following updated timeline that relates to the development and implementation of this fallback language.
    • Late February 2020 – New consultation on the Linked vs. Elective Approach to pre-cessation fallbacks
    • Late March 2020 – Deadline for consultation responses on new pre-cessation consultation
    • Late April 2020 -Early May 2020 – Publication of new pre-cessation consultation results and related announcements of next steps for implementing permanent and pre-cessation fallbacks
    • First half of 2020 – Publication of indicative fallback rates
    • TBD – Publication of amendments to the 2006 ISDA Definitions and related LIBOR-fallback protocol
    • 3 to 4 months After Publication – Effectiveness of amendments to the 2006 ISDA Definitions
  • No Cost for Adherence by Buy-Side Firms During First Three Months – ISDA’s February 6th announcement also confirmed that, “Regardless of how ISDA implements pre-cessation and permanent cessation fallbacks, the relevant protocol will be free for buy-side firms to adhere during the approximately three-month period before it takes effect.” (Emphasis added.)

Good day.  Good use of bullet points? DR2