The Steps to Benchmark Reform

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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.

The reforms to interest rate benchmarks will have a big impact across financial markets, from Wall Street to Main Street. Making sure the entire market appreciates the scale of the issue and takes early action is therefore a priority. The question is where to start with implementation. ISDA and our partner trade associations have tried to help with that question, publishing a checklist of steps firms can take now.

Most of those steps focus on getting internal processes in place and analyzing interbank offered rate (IBOR) exposures. That might sound obvious, but it’s incredibly important. According to a survey of 150 global institutions we published last week, more than half of respondents have initiated internal discussions on benchmark reform, but only a small proportion have allocated budget and resources. This is something firms can get started on now – mobilize a formal transition program, assign budget, establish a governance structure and set up workstreams with clear mandates.

As a next step, organizations should assess the extent of their exposure to IBORs and determine the expected roll-off of those positions. Analysis by regulators suggests most current IBOR positions will roll off before the end of 2021 – the date the UK Financial Conduct Authority has said it will no longer persuade or compel banks to make LIBOR submissions. Understanding this and making an early move to adopt alternative risk-free rates (RFRs) for new trades could substantially reduce the size of legacy IBOR positions by end-2021.

Another important step is to review fallback language within existing contracts and understand the impact of a permanent cessation of an IBOR. Organizations need to know what their contracts would reference if an IBOR ceases to exist, and determine whether that fallback is sufficiently robust. The industry is helping in this regard. ISDA is working on an initiative to implement robust fallbacks (the alternative RFRs) for derivatives referenced to certain key IBORs, which will be included in the ISDA definitions for interest rate derivatives. As part of this effort, we’re about to launch a market-wide consultation on the adjustments that should be made to the alternative RFRs to ensure contracts continue to function as closely as possible to what was intended if a fallback kicks in.

The next steps involve clearly communicating, both internally and externally. Institutions should convey to clients the actions they intend to take – not least because a transition to RFRs is not something that can be done unilaterally. Ultimately, a clear transition roadmap needs to be developed and communicated throughout the organization.

We think it’s important that firms adopt this checklist and begin working through each of the steps immediately. A key finding from our survey was that awareness of IBOR issues is high – 87% of respondents say they are concerned about their exposure to the IBORs, and 78% say they intend to trade an RFR within the next four years. However, there is a gap between this awareness and concrete steps taken to date – about a quarter of respondents have not yet initiated transition plans.

Given the scale of the task, this is not something that can be resolved in the months before end-2021. To ensure a successful and orderly transition, institutions need to be taking action – and starting now.

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