As we have previously reported, in July 2017, the UK Financial Conduct Authority announced that it would no longer use its legal powers to persuade or compel contributing banks to make the transaction data submissions necessary to determine the London Interbank Offered Rate (LIBOR) after the end of 2021.1 Since that time, on their own and with pressure from regulators, individual market participants, various industry associations and other working groups have been preparing for “life without LIBOR.” 2
Last week, the International Swaps and Derivatives Association (ISDA) jumpstarted this process by announcing its publication of the effective dates for its two-pronged solution to address the anticipated cessation of the officially sanctioned use of LIBOR and other Interbank Offered Rates for various currencies (including US dollars, British pounds sterling, Euros, Swiss francs and Japanese yen) as recognized primary benchmarks for rates of interest or for determining other payments used in myriad loans, deposits, derivatives, debt securities and other investments. ISDA’s efforts represent a major step in the financial markets’ transition away from LIBOR since its solution allows a uniform and efficient process for migration of the trillions of dollars of derivatives transactions, the bulk of outstanding transactions using LIBOR and other IBORS, to new benchmarks. The markets’ acceptance of ISDA’s solution has been swift with over 400 major swap dealers and other financial institutions agreeing to its adoption.3
ISDA’s solution consists of two parts: (i) the ISDA IBOR Fallbacks Supplement, which will amend the ISDA definitions4 used to determine LIBOR and the other IBORs in transactions using the over-the-counter derivatives master agreements published by ISDA (ISDA Master Agreements) on a going-forward basis; and (ii) a related ISDA IBOR Fallbacks Protocol (the Protocol), which allows parties to incorporate the same amendments to these definitions in pre-existing “legacy” transactions and agreements, including those transactions documented only under ISDA Master Agreements, but also under a wide range of other agreements listed in the Protocol.5
On Friday, October 23, 2020, ISDA opened the adherence period for the Protocol. The adherence period will last until the ISDA IBOR Fallbacks Supplement and the Protocol become effective on January 25, 2021. For parties who adhere after the official adherence period, the Protocol will become effective only upon the adherence of both counterparties to an in-scope agreement.
ISDA’s documentation provides fallback rates that will apply in the event LIBOR is no longer published due to: (i) a permanent discontinuation as evidenced by a public statement by or on behalf of the benchmark administrator or regulator of such administrator; or (ii) an announcement by the FCA that LIBOR is no longer representative. The fallback rates will not apply to in-scope agreements until the date of the actual discontinuation or non-representativeness of LIBOR. On the actual replacement date, the fallback rate “Adjusted SOFR” will apply on a compounded basis. A spread will apply to “Adjusted SOFR” to correct for the difference between a secured and an unsecured rate (to the extent possible). The spread methodology will be based on a historical five-year median between LIBOR and SOFR. Because “Adjusted SOFR” will not be known until the end of the interest period, a two-day-banking-day backward-shift adjustment will be added for operational purposes.
Although the Protocol amends legacy derivatives agreements that may be used for various purposes, adherents do not have the opportunity to tailor the Protocol to ensure that such amendments are suitable for the parties involved, except through bilateral amendments of the Protocol. Anticipating that certain bilateral amendments of the Protocol will be common, ISDA has published template bilateral amendments to allow for: (i) bilateral adoption of the amendments made by the ISDA IBOR Fallbacks Protocol, including negotiated amendments;6 (ii) exclusion of certain specified agreements from the scope of the ISDA IBOR Fallbacks Protocol; (iii) inclusion of certain specified agreements not already within the scope of the ISDA IBOR Fallbacks Protocol; and (iv) the deletion of the non-representativeness “trigger.” Parties may also agree to other bilateral amendments of the ISDA IBOR Fallbacks Protocol, such as calculation agent dispute resolution provisions, but will need to draft such amendments independently. In addition to the ability to make amendments to the Protocol when adopting it bilaterally, ISDA has published templates for amending the Protocol that has been adopted through its adherence process, through bilateral amendment with specific counterparties.
Although ISDA’s LIBOR fallback solution attempts to provide an easy fix to a complicated problem, entities considering this one-size-fits-all approach should carefully consider whether or not to include amendments to the Protocol to address the circumstances existing in their legacy transaction portfolio. For example, buy-side entities that use derivatives to hedge cash market instruments, e.g., loans, floating rate debt or investments whose return or payment obligations are based on LIBOR, should be particularly sensitive to discrepancies between ISDA’s LIBOR fallbacks and the LIBOR fallbacks in such instruments, and the alternative fallbacks developed by various industry working groups for cash instruments.7 Such buy-side entities may face basis risk due to differences in LIBOR fallback language for hedged cash instruments and hedging derivatives. To minimize such basis risk, parties may want to remove the hedging derivatives agreements from the scope of the ISDA IBOR Fallbacks Protocol and provide that such derivatives agreements incorporate the LIBOR fallback language provided for the hedged cash market instrument.
The timing of when amendments should be negotiated should also be considered. Although adherents may enter into bilateral amendments of the ISDA IBOR Fallbacks Protocol at any time before or after adherence, buy-side entities will likely have less leverage to put such bilateral amendments in place once they have adhered to the ISDA IBOR Fallbacks Protocol as-is. However, notwithstanding the potential advantage of negotiating amendments before adherence to the Protocol, this option may be limited to the extent there is a desire to have the Protocol in place by its effective date and the effective date of the IBOR Fallbacks Supplement in January. Recognizing this tight time frame, potential adherents should approach their counterparties to address the need for amendments, e.g., to exclude certain transactions as noted above, even if such amendments are not put in place before both parties have adhered to the Protocol.
To assist in the decision making process with respect to the ISDA IBOR Fallback Supplement and the Protocol, and the LIBOR transition generally, we have included the following links to the ISDA IBOR Fallback Supplement and the Protocol, ISDA’s website on the LIBOR transition and certain other materials provide by ISDA, Bloomberg, the ARRC and the U.K. Financial Conduct Authority:
─ ISDA’s LIBOR Page, which serves as the central repository for information from ISDA relating to financial benchmark reform and the transition from LIBOR and includes The ISDA IBOR Fallbacks documentation and the ISDA/Bloomberg/Linklaters white paper on fallbacks methodology and relevant contractual provisions: https://www.isda.org/2020/05/11/benchmark-reform-and-transition-from-libor/
─ Bloomberg’s LIBOR transition page, which includes links to Bloomberg’s IBOR Fallback Rate Adjustments Rule Book, the IBOR Fallback Fact Sheet, IBOR Fallback Test Data, and an IBOR Fallback Sample Calculation: https://www.bloomberg.com/professional/solution/libor-transition/
─ Proposed Legislative Solution to Minimize Legal Uncertainty and Adverse Economic Impact Associated with LIBOR Transition (ARRC’s New York Solution): https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2020/ARRC-Proposed-Legislative-Solution.pdf
─ Press release on the publication of the ISDA Benchmarks Supplement that includes links to the ISDA Benchmarks Supplement (available on the “Library” section of the ISDA website (login required)): https://www.isda.org/2018/09/19/isda-publishes-benchmarks-supplement/
─ ARRC Fallback Contract Language page, which includes fallback language for, among other products, floating rate notes and loans: https://www.newyorkfed.org/arrc/fallbacks-contract-language
1. Legal Alert by Eversheds Sutherland, Changes to the London Interbank Offering Rate (LIBOR) are coming, will you be ready? (August 21, 2018), available at https://us.eversheds-sutherland.com/NewsCommentary/Legal-Alerts/213747/December-31-2021-changes-to-the-London-Interbank-Offered-Rate-LIBOR-are-comingwill-you-be-ready
2. Legal Alert by Eversheds Sutherland, OCIE examining LIBOR transition preparedness – How investment companies should prepare now (July 31, 2020), available at https://us.eversheds-sutherland.com/NewsCommentary/Legal-Alerts/234343/OCIE-examining-LIBOR-transition-preparedness-How-investment-companies-should-prepare-now; Legal Alert by Eversheds Sutherland, The heat is on - Regulators step up pressure to implement LIBOR transition plans (January 13, 2020), available at https://us.eversheds-sutherland.com/NewsCommentary/Legal-Alerts/228102/The-heat-is-onRegulators-step-up-pressure-to-implement-LIBOR-transition-plans; Legal Alert by Eversheds Sutherland, Regulatory guidance on the transition away from LIBOR (July 26, 2019), available at https://us.eversheds-sutherland.com/NewsCommentary/Legal-Alerts/222795/Regulatory-guidance-on-the-transition-away-from-LIBOR
3. Available at https://www.isda.org/protocol/isda-2020-ibor-fallbacks-protocol/adhering-parties; amount of adherence as of November 5, 2020.
4. Supplement number 70 to the 2006 ISDA Definitions.
5. See the Additional Documents Annex to the Protocol, which includes Master Repurchase Agreements as an additional document that is in-scope for purposes of the Protocol.
6. Bilateral adoption of the Protocol may be particularly important for transactions with counterparties with limited transactions who do not intend to adhere to the Protocol through ISDA.
7. The Alternative Reference Rates Committee has recommended fallback contract language for various new cash products, see https://www.newyorkfed.org/arrc/fallbacks-contract-language.