Regulators and industry groups strongly encourage market participants to adopt ISDA’s much-anticipated IBOR Fallbacks Protocol and Definitions Supplement.

By Yvette D. Valdez, Becky Critchley, Deric Behar, and Anna Lewis-Martinez

The International Swaps and Derivatives Association (ISDA) has published a statement from its Board of Directors confirming that on October 23, 2020 it will launch its IBOR (interbank offered rates) Fallbacks Protocol (the Protocol) and IBOR Fallbacks Supplement to the 2006 ISDA Definitions (the Supplement). The Supplement and the Protocol’s amendments will take effect on January 25, 2021.

According to ISDA’s October 9 announcement, all new derivatives contracts that incorporate the 2006 ISDA Definitions and reference one of the covered IBORs will contain the new fallbacks as of January 25, 2021. Derivatives contracts existing as of this date will also incorporate the new fallbacks if both counterparties have adhered to the Protocol or otherwise bilaterally agreed to include the new fallbacks in their contracts.

UK Working Group Welcomes Early Adherence to the Protocol

Following ISDA’s announcement, the Bank of England, the Working Group on Sterling Risk-Free Reference Rates (RFRWG), and the UK Financial Conduct Authority (FCA) issued a joint statement strongly urging both financial and non-financial counterparties to adhere to the Protocol and to adopt the Supplement for sterling products. In a previous speech by Edwin Schooling Latter, Director of Markets and Wholesale Policy at the FCA, the UK regulator was clear that market participants must be sure to sign the protocol within the adherence period offered by ISDA after publication. Firms with major uncleared derivative exposures that choose not to sign the protocol “will need to be ready for some serious questions from [FCA] supervisors on how they will mitigate these risks.”

As a reminder to firms, the RFRWG’s Roadmap for LIBOR Transition, which was updated and published in late September 2020, sets out target milestones for each type of Sterling LIBOR linked product, e.g., derivatives, bonds, securitizations, and loans.

US ARRC Promotes Early Adherence to Mitigate Risks

The US Alternative Reference Rates Committee (ARRC) issued a statement on the same day as ISDA’s announcement, stating that it fully supports this month’s launch of the Protocol and Supplement. The ARRC encourages market participants to adhere to the Protocol before it takes effect, and encourages those dealers and market participants with significant derivatives exposures to adhere to the Protocol during the two-week escrow period ahead of the official launch date on October 23, 2020, in order to promote adoption on as timely a basis as possible.

ARRC Chair and Vice Chairman of Institutional Securities at Morgan Stanley, Tom Wipf, highlighted, “It is essential that market participants be prepared to adhere to the Protocol to help address both individual firm risks and systemic risks associated with the discontinuation of LIBOR. Adoption of the ISDA Protocol is a vital step in the transition to more robust rates, such as SOFR.”

FSB Also Encourages Broad and Timely Adherence to the Protocol

In addition, the Financial Stability Board (FSB) has published a press release encouraging adherence to the Protocol by all affected financial and non-financial firms which will “be a major driver of transition for derivatives in all LIBOR currencies and a critical step in benchmark transition ahead of end-2021.” The FSB adds that market participants choosing not to adhere for some or all of their trades will need to take robust alternative steps, such as closing out these positions or appropriate bilateral amendments, to avoid the risk of disruption.

To assist with the transition, on October 16, 2020 the FSB issued a Global Transition Roadmap for LIBOR, to highlight some of the “prudent steps” market participants should be taking to successfully mitigate LIBOR exposure risks. The FSB also “strongly encourage[s]” adherence to the protocol by the effective date, or in the alternative, implementation of other appropriate risk mitigation arrangements.

ARRC’s Proposed LIBOR Legislation in New York Still Lacks Support

In contrast to the enthusiastic response to ISDA’s announcement and impending launch, the ARRC’s proposed New York legislation to minimize legal uncertainty and adverse economic impact associated with LIBOR transition is reportedly making little headway. The draft legislation has yet to find a state senator or assembly member to sponsor it for consideration before the Legislature. And because the 2020 New York legislative session has already concluded, the earliest a bill could be introduced is now January 2021.

Latham & Watkins will continue to monitor developments in this area.