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ISDA has been leading an industry effort to implement robust fallbacks for derivatives contracts referenced to certain IBORs since 2016, at the request of the Financial Stability Board’s Official Sector Steering Group (FSB OSSG). Following consultation with industry participants, regulators and the FSB OSSG, the fallback rates will be the risk-free rates (RFRs) identified as alternatives for the relevant IBORs as part of global benchmark reform efforts. These fallbacks will be included in the ISDA definitions for interest rate derivatives and will apply to new IBOR trades. ISDA will also publish a protocol to allow participants to include the fallbacks within legacy IBOR contracts, if they choose to.
The consultation sets out possible options for adjustments to the RFRs to ensure legacy derivatives contracts referenced to an IBOR continue to function as close as possible to what was intended after a fallback takes effect. These adjustments reflect the fact that the IBORs are currently available in multiple tenors – for example, one, three, six and 12 months – but the RFRs are overnight rates. The IBORs also incorporate a bank credit risk premium and a variety of other factors (such as liquidity and fluctuations in supply and demand), while RFRs do not.
The consultation sets out four options to account for the move from a term rate to an overnight rate:
Three options are also proposed to calculate a spread adjustment:
In each case, the spread adjustment will be fixed at the point the fallback is triggered.
The consultation will run for three months and is open to all market participants. ISDA will accept responses until October 12th, 2018.