Another Look at Pre-cessation

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.

Back in December, we told the Financial Stability Board’s Official Sector Steering Group (FSB OSSG) that we would press ahead with our work on permanent cessation fallbacks, but would consider re-consulting on pre-cessation fallbacks if certain new information came to light. Given recent developments – including letters from the UK Financial Conduct Authority (FCA) and ICE Benchmark Administration (IBA) published last month – we think there’s a strong rationale to go out to the market on this issue once again.

We appreciate this consultation comes on the back of several others, but it’s vitally important that market participants continue to engage. This new consultation will determine whether pre-cessation fallbacks should be linked with permanent cessation fallbacks as standard language in the amended 2006 ISDA Definitions and in a single protocol, with no optionality. If there is sufficient support for this approach, it would mean a fallback would take effect if a covered interbank offered rate (IBOR) ceases to exist or a regulator announces it is no longer representative of the underlying market, whichever comes first.

If there isn’t enough support, then ISDA will amend the 2006 ISDA Definitions to implement permanent cessation fallbacks and add in an option for derivatives counterparties to include pre-cessation fallbacks if they want to. A protocol for legacy contracts would also be launched with similar functionality. Either way, the protocol will be free for buy-side firms to adhere during the approximately three-month period before it takes effect.

This will be the second time ISDA has consulted on pre-cessation issues. The first took place between May and July 2019, and found there was no consensus on how to implement pre-cessation fallbacks, even though most respondents generally agreed they would prefer not to continue referencing an IBOR in existing or new derivatives contracts following a statement from a supervisor that it is no longer representative.

So, why run another consultation?

Simply, more information is now available to the market. In the December letter to the FSB OSSG, we called for further clarity on two important issues – the ‘reasonable period’ during which a non-representative LIBOR would be published, and the specific action central counterparties would take if the UK FCA determines that LIBOR is non-representative.

There have been recent developments on both topics. In late-January, letters from the FCA and IBA provided additional insight on the length of time a non-representative LIBOR would be published, while LCH introduced a rule book change to implement pre-cessation fallbacks, which is open to consultation until March 23.

The latest ISDA consultation – which we plan to launch later this month – means the timing for publication of the amendments to the 2006 ISDA Definitions and the protocol will now depend on the results of that outreach, and we’ll update the market with the new timetable as soon as possible.

In the meantime, ISDA will continue to work with Bloomberg to publish indicative spread calculations and all-in fallback rates during the first half of 2020 to help facilitate operational readiness for fallback implementation.

Fallbacks will go a long way to reducing the systemic risk posed by ongoing exposure to IBORs. It’s therefore important we arrive at a solution that has broad industry support. Whatever the outcome, this consultation will help achieve that objective.

Want to learn more about in benchmark transition? Come to the ISDA/SIFMA Benchmark Strategies Forum in New York on February 12 and London on February 26. Registration is free for the buy side.

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