The Alternative Reference Rates Committee ("ARRC") updated its recommendations for swaptions that may be impacted by the shift in discounting rates used by clearinghouses.
Following its consultation on a compensation methodology for U.S. dollar LIBOR-referencing swaptions (see previous coverage), the ARRC made two recommendations on May 14, 2020 regarding legacy swaptions traded before March 30, 2020. Among other things, at the time, the ARRC recommended that market participants:
- amend U.S. dollar swaptions that are set to expire after October 16, 2020 (the date of the clearinghouse switch) to (i) be in-scope for Supplement 64 to the ISDA Definitions, (ii) indicate that the Secured Overnight Financing Rate (SOFR) is the agreed discount rate and (iii) exchange compensation for the difference in the value of these swaptions; and
- contact counterparties by June 30, 2020 to indicate whether they intend to follow the above recommendations.
The ARRC stated that after it issued these recommendations, it became clear that some market participants are choosing to forgo an exchange of compensation. Accordingly, the ARRC made the additional recommendation that, should counterparties fail to reach an agreement regarding the exchange of compensation before October 16, 2020, they should (i) amend their legacy swaptions to be in-scope for ISDA Supplement 64 and (ii) designate an agreed discount rate that is consistent with the existing contractual terms of the swaptions.
Commentary
As it notes in its recommendation, the ARRC really aligns its views closer to current market practice. A number of firms have declined to follow the initial compensation recommendation.
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