On September 19, 2018, the International Swaps and Derivatives Association, Inc. (ISDA) published the ISDA Benchmarks Supplement, which allows adhering entities to amend the contractual triggers and fallbacks of over-the-counter derivatives documentation that reference interest rate, FX, equity and commodities benchmarks, under current ISDA definitions incorporated into transactions using ISDA derivatives documentation.1
Although the ISDA Benchmarks Supplement has primarily been produced to address certain requirements under the EU Benchmark Regulation,2 its application is not limited to compliance with the EU Benchmark Regulation, and parties may incorporate the ISDA Benchmarks Supplement on a voluntary basis or in accordance with the Statement on Matters to Consider in the Use of Financial Benchmarks.3
Impact on Entities That Are Not Subject to the EU Benchmark Regulation
Article 28(2) of the EU Benchmark Regulation, which applies from January 1, 2018, requires that, if a party to a transaction is a supervised entity user, such party must produce and maintain “robust written contingency plans” setting out the actions that it will take if a benchmark that it uses materially changes or ceases to be produced. The EU Benchmark Regulation’s definition of “supervised entities” that are directly subject to the Regulation includes credit institutions, investment firms, insurance undertakings, reinsurance undertakings, undertakings for collective investments in transferable securities (UCITS), alternative investment fund managers, institutions for occupational retirement provisions, creditors and non-credit institutions for the purposes of credit agreements, market operators, central counterparty clearing houses and trade repositories. The contingency plans must be reflected in client-facing documentation and provided to a relevant regulator on request. Accordingly, to continue trading with supervised entity users, market participants that are not directly subject to the EU Benchmark Regulation, including non-EU entities, may be required to enter into such contingency plans or, alternatively, adhere to the ISDA Benchmarks Supplement on a going-forward basis.
Supplementing the ISDA Definitional Booklets
If parties adhere to the ISDA Benchmarks Supplement, certain provisions of the ISDA definitional booklets will be supplemented if a benchmark permanently ceases to exist (the cessation trigger)4 or may no longer be used pursuant to applicable regulation, if any (the regulatory trigger).5 Upon the occurrence of the cessation trigger or the regulatory trigger, if applicable, the parties will apply a variety of fallbacks to determine an alternative benchmark or, ultimately, terminate the affected transaction(s).
Cessation of LIBOR versus the ISDA Benchmarks Supplement
Due to the recent attention surrounding the potential cessation of the London Interbank Offered Rate (LIBOR) and the Interbank Offered Rate (IBOR), and ISDA’s work to implement fallbacks to LIBOR and IBOR, market participants may be inclined to consider the effects of the ISDA Benchmarks Supplement in the same light. However, the ISDA Benchmarks Supplement covers a broader range of benchmarks than the affected LIBOR and IBOR. In addition, ISDA’s work to implement fallbacks specific to LIBOR and IBOR could, once completed, trump the ISDA Benchmarks Supplement’s fallbacks with regard to LIBOR or IBOR transactions to which both work streams apply.6 However, until ISDA has completed its work on LIBOR and IBOR, the ISDA Benchmarks Supplement will determine the primary fallbacks that apply to LIBOR and IBOR. ISDA is expected to complete its work to implement fallbacks to LIBOR and IBOR in mid-to-late 2019.
Incorporating the ISDA Benchmarks Supplement into ISDA Derivatives Transactions
The ISDA Benchmarks Supplement provides market participants one avenue to comply with the EU Benchmark Regulation, but it may equally be used by parties that wish to incorporate its provisions into transactions that are not subject to the EU Benchmark Regulation. Although ISDA has indicated that the adherence process will include a protocol, the protocol platform has not yet been established, and it is unclear when work on this platform will be completed. By default, parties should adhere to the ISDA Benchmarks Supplement on a going-forward basis, but ISDA may also allow for the inclusion of legacy transactions. When electing to include legacy transactions, parties should be aware of local regulatory requirements that may apply to existing derivatives contracts that are amended to include new fallbacks.7
1 The ISDA Benchmarks Supplement applies to one or more of the following ISDA definitional booklets: (i) 2006 ISDA Definitions (related to the interest rate and cross-currency swaps and options transactions); (ii) 2002 ISDA Equity Derivatives Definitions; (iii) 1998 FX and Currency Option Definitions; and/or (iv) 2005 ISDA Commodity Definitions.
2 Regulation (EU) 2016/1011 of the European parliament and of the Council of June 8, 2016, on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds and amending Directives 2008/48/EC and 2014/17/EU and Regulation (EU) No 596/2014.
3 International Organization of Securities Commissions, Statement on Matters to Consider in the Use of Financial Benchmarks (January 5, 2018), available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD589.pdf.
4 For purposes of the EU Benchmark Regulation, the cessation trigger corresponds with Article 28(2)’s requirement to produce and maintain “robust written contingency plans” in client-facing documentation.
5 For purposes of the EU Benchmark Regulation, the regulatory trigger corresponds with Article 29(1)’s prohibition from using a benchmark in the EU, unless such benchmark is approved by an administration located in the EU or provided by an administration outside the EU and, in each case, is included in the register of administrators and benchmarks maintained by the European Securities and Markets Authority.
6 Changes to the LIBOR and IBOR definitions will likely apply by default only to transactions on a going-forward basis unless the parties agree otherwise, e.g., that such changes apply to legacy transactions as well.
7 In the United States, the Alternative Reference Rate Committee has requested guidance from regulators regarding whether certain amendments of existing derivatives contracts to include new fallbacks trigger regulatory requirements, including mandatory clearing, reporting and recordkeeping, and reconciliation. The Alternative Reference Rate Committee’s letter specifically addresses amendments in connection with the Secured Overnight Financing Rate, the anticipated successor of the London Interbank Offered Rate. Alternative Reference Rate Committee, LETTER REGARDING TREATMENT OF DERIVATIVES CONTRACTS REFERENCING THE ALTERNATIVE RISK-FREE RATES AND ASSOCIATED TRANSITIONS UNDER TITLE VII OF THE DODD-FRANK WALL