In May 2019, the International Swaps and Derivatives Association (ISDA) released two consultations for public comment. One of the consultations focused on spread and term adjustments for fallbacks in derivatives referencing USD LIBOR, CDOR, HIBOR, and SOR (the 2019 Supplemental Consultation), while the other consultation focused on issues related to the potential inclusion in derivatives documentation of language that would trigger the transition to a fallback rate before an IBOR has actually ceased being published (this is known as a “pre-cessation trigger,” and we refer to this consultation as the “2019 Pre-Cessation Consultation”). Chatham responded to both ISDA consultations in July 2019, and our responses were focused on the potential impacts of ISDA’s proposals on derivatives end users.
Fallback and spread in the Supplemental Consultation
In our response to the 2019 Supplemental Consultation, Chatham advocated for a compound setting in arrears rate for the fallback and a forward approach for the spread adjustment. In a prior 2018 ISDA consultation on IBOR fallbacks, Chatham had previously preferred the historical mean/median approach for the spread, but because Chatham has observed that U.S. market conditions have changed since the release of the 2018 ISDA consultation results, we now prefer the forward spread approach since it allows the spread to evolve based on market forces rather than remain static based on historic spread calculations. ISDA has released preliminary results of the 2019 Supplemental Consultation, and while most respondents agreed with Chatham’s preference for compounded setting in arrears for the fallback rate, the majority of respondents disagreed with Chatham on the spread and preferred the historical mean/median approach over the forward approach. Although the number of respondents to this consultation was somewhat low, it is likely that ISDA will use the compounded setting in arrears rate and the historical mean/median approach for the spread when it amends its 2006 ISDA Definitions for use in derivatives documentation.
Determining the end of LIBOR in the Pre-cessation Consultation
In Chatham’s response to the 2019 Pre-cessation Consultation, we emphasized that maintaining flexibility is crucial for end users at this stage, and we did not universally recommend including pre-cessation triggers in derivatives documentation at this time since there are still so many uncertainties around IBOR fallbacks. ISDA’s preliminary results for this consultation noted that respondents generally fell into the following three categories, with no clear majority in any one category: 1) those who supported the inclusion of a pre-cessation trigger in ISDA’s Definitions, 2) those who only supported the inclusion of a pre-cessation trigger if it is implemented with optionality and flexibility, and 3) those who opposed the inclusion of a pre-cessation trigger.
ISDA issued a new consultation on the final parameters for the spread and term adjustments for their fallback language. Chatham will submit our response to this consultation in late October 2019. You can find Chatham’s complete responses to previous ISDA consultations here: 2019 Supplemental, 2019 Pre-cessation, 2018 Aspects of Fallbacks for Derivatives.
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