Now is the Time to Think About Benchmarks

ISDA Chief Executive Officer Scott O'Malia offers informal comments on important OTC derivatives issues in derivatiViews, reflecting ISDA's long-held commitment to making the market safer and more efficient.

With everything going on – implementation of MIFID II, Brexit negotiations and publication of the latest Basel measures – it’s difficult to look too much beyond 2018, let alone the end of 2021. That’s the date Andrew Bailey, chief executive of the UK’s Financial Conduct Authority, has said the regulator will no longer compel or persuade banks to make submissions to LIBOR (although panel banks have agreed to submit until then). But the task of transitioning from the IBORs to new risk-free rates (RFRs) is immense, and the industry can’t afford to kick the can down the road. Everyone needs to start thinking about what this means for them now.

There has been progress. Public-private sector working groups in the US, UK and Japan have already settled on their choice of RFRs, and have begun planning for transition. Europe also now has its own working group of public- and private-sector participants to consider the issue. But there are a whole host of challenges that need to be thought through by the industry – from dealing with possible value transfer and potential liquidity issues, to the requirement by certain investors for term fixings and the possible regulatory and capital implications of switching legacy trades to alternative RFRs. The scale of the task, both in terms of volume of outstanding contracts and the breadth of sectors affected, is unprecedented.

ISDA has decided to think about these issues now. Last month, we announced that we’re working on a comprehensive report that will consider how the IBORs are currently used across financial markets, including in derivatives, loans, bonds and mortgages. It will highlight likely challenges in any transition, and outline identified solutions. Central to the report will be global survey of buy- and sell-side firms, trade associations and infrastructure providers that will take place either side of the holidays.

The intention is to build on the work being done by the various public-private sector working groups, and to consider the issues on a global basis. We’re not saying this report will have all the answers – but it should at least identify the main issues and possible solutions. If you’re closely involved in benchmarks at your firm, then we would value your input.

Separately, work is continuing on an initiative to develop robust fallbacks for certain key IBORs. These two projects are often confused – which isn’t surprising as the issues and challenges are similar. In short, if the RFR initiatives are about encouraging a managed, orderly transition to RFRs with a possible deadline of end-2021, then the fallback work is meant to address what would happen for anyone yet to transition their positions if an IBOR ceases to be published as certain trigger events occur. Having a clearly defined fallback plan written into contracts will help minimize any disruption this might cause.

The ISDA working groups considering the issue have proposed using the relevant RFRs identified by the public-private sector initiatives where they are available. But many of the same challenges facing the transition work have emerged here too – how to minimize value transfer, how to treat the absence of term fixings, how to deal with the fact the IBORs reflect bank credit risk while RFRs do not.

The two initiatives are closely coordinated – many of the same participants, including ISDA, are involved in both. But the two are working to different timelines – a possible end-2021 date for transition, and ASAP for fallbacks. That could mean the solutions developed to address these challenges for fallbacks may differ to the solutions established for transition. All this is taking place against the backdrop of the European Union Benchmarks Regulation, which requires supervised entities to produce plans from January that set out the steps they will take in the event a benchmark ceases to be published. ISDA is currently working on a supplement to help participants meet this requirement.

ISDA will keep the industry updated on all of these initiatives throughout 2018. That’s when we expect the rubber to really hit the road, and for the challenges and solutions to be fleshed out. But market participants shouldn’t wait to start thinking about how a shift from the IBORs will affect them. Now is the time for each firm to comprehensively identify how they use the IBORs – to what extent is an IBOR-referenced rate paid or received on loans, bonds or derivatives, and to what degree is it used as a discount rate to determine liabilities? Only armed with this information will firms be in a good position to meet the challenges faced by these changes.


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