Isda Seeks Vendor to Publish IBOR Fallback Rate Adjustment Data

The International Swaps and Derivatives Association (Isda), the trade organization for the over-the-counter (OTC) derivatives industry, is soliciting vendors to publish rate adjustments once interbank offered rates (IBORs) are discontinued. 

The bank associations and benchmark administrators that produce IBOR lending rates will stop publishing IBORs in December 2021 or shortly thereafter, by which time financial firms are expected to have already reduced their exposure to IBORs and to have transitioned to risk-free rates (RFRs). The contractual terms that govern these IBOR replacement rates are known as “fallbacks.”

Speaking at the Isda annual legal forum held on January 28, Edwin Schooling Latter, director of markets and wholesale policy at UK regulator the Financial Conduct Authority, said Isda’s work on fallbacks will help mitigate any upset to the derivatives markets once the London Interbank Offered Rate (LIBOR) comes to an end.

“Wide adoption of the new fallbacks will help reduce the risk of market participants finding themselves in disagreement or costly dispute on their rights and obligations attached to LIBOR-referencing contracts, or with positions split across multiple different fallback arrangements,” Schooling Latter said. “For new transactions, adoption will be by way of the Isda definitions for interest rate derivatives. For legacy contracts, it will be achieved by signing the protocol implementing this fallback arrangement.”

At the request of the Financial Stability Board, Isda began working on the implementation of fallbacks in 2006 and finished in 2017, but has spent the last two years updating the definition to provide a transparent rate that will apply to any contracts that reference a discontinued IBOR. 

On a conference call held on January 25, Isda said it has been working on expanding the definition to include fallbacks based on RFRs that are entirely different to the IBORs. The differences in term structures and credit risk between the IBORs and RFRs were fundamental for calculating new adjustments.  

“When we talk about fallbacks, we’re talking about a contract that counterparties have entered into based on the relevant IBOR, and they now need to plan for the potential that that same contract that they’ve built around the IBOR will no longer have an IBOR to reference, and instead they have a risk-free rate,” said an Isda official on the call. 

Fallback rates will be adjusted to fit contracts built on a different rate, making this a complex process. This may pertain to a large number of contracts, depending on the amount of outstanding IBOR contracts a firm has. 

Although the calculations for the new rate option will be made public, Isda is also seeking a vendor to publish the spread adjustment via some kind of electronic mechanism for market participants. In the event that market participants don’t have the resources to calculate the rate themselves—or choose not to—firms will be able to “look at a screen and find out exactly the rate their contracts reference,” the Isda official said.

“Any time there are calculations, you have to contemplate that there could be a dispute between counterparties that both perform a calculation, and you have to have mechanisms to resolve any disputes,” the Isda official said. “So, instead of addressing all of those issues, it will be much more user-friendly and a much more seamless transition to fallback rates if all of that information is on the screen.”

The chosen vendor must be able to use and obtain the data required to calculate Compounded Setting In Arrears Rate and the spread adjustment based on a historical mean and median approach, run the calculations, then publish them. This requires that the vendor has all regulatory approvals and authorizations to produce the rate and can come to commercially agreeable terms with Isda, and does not have any conflicts of interest relating to the discontinuation of the IBORs. 

“Isda will reference the vendor publishing this information in the documentation that it publishes,” the Isda official said. “The agreement or the ongoing relationship with Isda and the vendor is something that will have to be worked out as part of this process.”