Introducing robust fallbacks for derivatives contracts is a vitally important step in mitigating the systemic risk that could arise from the cessation of a key interbank offered rate (IBOR). After nearly four years of work, ISDA is now on the cusp of publishing a supplement to the 2006 ISDA Definitions plus a related protocol that will make those fallbacks a reality. As we approach the launch, we want to ensure the expected timetable is as transparent as possible, which is why we sent a letter to regulators earlier this week to flag that we now expect the effective date for the supplement and protocol to be in mid- to late-January 2021.

As we point out in the letter, the timetable hinges upon ISDA receiving a positive business review letter from the US Department of Justice (DoJ) and then finalizing work with competition authorities in other jurisdictions. Although ISDA has been in regular contact with competition authorities over the past few years, we have no control over the timing of this feedback.

Once we hear from the competition authorities, we’ll give market participants approximately two weeks’ notice of the official launch date. During this short period, firms will be able to adhere to the protocol ‘in escrow’. In other words, parties will be able to sign up on a binding but non-public basis so their adherence takes effect as soon as the protocol launches. As there is no regulation requiring institutions to incorporate new fallbacks into legacy trades, having backing for the protocol from day one will hopefully establish strong support for use of the fallbacks, even without a regulatory edict.

The supplement and protocol will officially launch after this escrow period. As with all ISDA protocols, the IBOR Fallbacks Protocol will be voluntary – firms could alternatively choose to make changes to their legacy contracts on a bilateral basis, or opt to keep their outstanding trades unchanged. However, in a statement published in July, the ISDA board of directors expressed its support for broad adherence, noting that it is the most efficient way for most derivatives participants to mitigate against the risks associated with the discontinuation of a key IBOR.

The supplement and protocol will then take effect approximately three months later. Market participants have strongly advised that we avoid an effective date at the end of the year, which would create operational challenges and coincide with the traditional code freeze period introduced by financial institutions in December. Putting the times for each of those phases together, the effective date will not occur before the second half of January 2021.

From that point on, all new derivatives referencing the 2006 ISDA Definitions will automatically include the updated fallbacks for covered IBORs. The changes will apply to legacy derivatives as well if both counterparties have adhered to the protocol or have agreed similar bilateral amendments. Certain central counterparties (CCPs) also plan to apply the updated fallbacks to all cleared over-the-counter derivatives from the effective date.

None of these steps can be shortened or missed out. The process of getting feedback from competition authorities, for example, is critical. ISDA has run multiple consultations over the past two years to reach industry consensus on the fallback methodology. This framework is aimed at mitigating the structural differences between IBORs and the risk-free rates that serve as the basis for the fallbacks, and to ensure trades referenced to an IBOR continue to meet their original objectives to the greatest extent possible if a fallback kicks in.

It’s possible that regulators could make an announcement before the end of this year on the future of LIBOR after 2021 – in fact, the FCA has suggested as much. However, if there is an announcement on post-2021 dates for the cessation and/or non-representativeness of LIBOR, then the spread adjustments set out under the fallback methodology would be calculated and frozen from that point. That process is set out in the rulebook implemented by Bloomberg in its role as calculation agent for the fallbacks, and is already in effect.

In other words, the calculation of the spread adjustment would occur in the same way, irrespective of whether a regulator announcement comes before or after the effective date of the supplement and protocol.

The timetable for benchmark reform over the coming months will busy – along with fallbacks, market participants will also need to prepare for the October switch by CCPs to SOFR discounting and price alignment interest for cleared US dollar interest rate derivatives. Many firms are also working to make the necessary changes to systems and processes to support alternative rates to IBORs. Benchmark fallbacks are an integral part of that overall reform effort. With the clock ticking to the end of 2021, it’s critical that firms have a safety net in place – something the fallbacks can provide.