ISDA initiated a "market-wide consultation" on issues concerning new benchmark fallbacks for derivatives contracts that reference certain interbank offered rates ("IBORs"). In a comprehensive consultation paper, titled Interbank Offered Rate (IBOR) Fallbacks for 2006 ISDA Definitions, ISDA "sets out options for adjustments that would apply to the fallback rate in the event an IBOR is permanently discontinued."

According to the consultation paper, fallback rates will apply to the alternative risk-free rates ("RFRs") that have been identified for relevant IBORs as part of recent global benchmark reform efforts. The consultation covers derivatives referencing GPB LIBOR, CHF LIBOR, JPY LIBOR, TIBOR, Euroyen TIBOR and BBSW. ISDA anticipates supplemental consultations covering USD LIBOR, EUR LIBOR and EURIBOR.

ISDA seeks input for certain technical issues associated with adjustments to the RFRs that will apply if the fallbacks are triggered. In the consultation paper, ISDA laid out several options, which are set forth in more detail below, for adjustments to the RFRs.

To address the move from a term rate to an overnight rate, ISDA will implement fallbacks that "apply an adjustment to the relevant overnight RFR so that it is comparable to the relevant IBOR." ISDA proposed four different approaches to calculate this adjustment:

  1. Spot Overnight Rate - the fallback potentially could be to the RFR that sets 1-2 business days before "the beginning of the relevant IBOR tenor";
  2. Convexity-Adjusted Overnight Rate - the approach is similar to that of the Spot Overnight Rate, with a modification to adapt for convexity, which attempts to account for the difference between "flat overnight interest at the spot overnight rate versus the realized rate of interest that would be delivered by [the] daily compounding of the RFR over the IBOR's term";
  3. Compounded Setting in Arrears Rate - the fallback could be to the "relevant RFR observed over the relevant IBOR tenor and compounded daily during that period"; and
  4. Compounded Setting in Advance Rate - this last option is similar to the Compounded Setting in Arrears Rate approach, but the observation period would end "prior to the start of the relevant IBOR tenor."

To address the move from an IBOR to a risk-free rate, ISDA proposed a spread adjustment to apply to serve as a rough proxy. ISDA proposed three options to calculate spread adjustment:

  1. Forward Approach - "[t]he spread adjustment could be calculated based on observed market prices for the forward spread between the relevant IBOR and the adjusted RFR in the relevant tenor at the time the fallback is triggered";
  2. Historical Mean/Median Approach - this approach could be based on the median spot spread "between the IBOR and the adjusted RFR calculated over a . . . static lookback period . . . prior to the relevant announcement . . . triggering the fallback provisions"; and
  3. Spot-Spread Approach - this last option could be predicated on the spot spread between the IBOR and adjusted RFR on the day before the announcement leading to the fallback provisions.

ISDA emphasized that it does "not discuss or cover whether the adjusted RFRs and spread adjustments would be appropriate for fallbacks in non-derivative securities or other financial products." In addition, the "fallbacks are not proxies for the relevant IBORs," but are meant to provide clarity and certainty if an IBOR is permanently discontinued.

The consultation is open to all market participants and will circulate for three months.

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