A private-sector working group on euro risk-free rates proposed guiding principles for fallback provisions in new contracts for euro-denominated cash products. The European Central Bank provided the secretariat for the working group.

The working group highlighted the importance of market participants adequately preparing for a transition to risk-free rates. The new fallback language, according to the working group, should take into account the following principles:

  • new fallback provisions should include a "permanent cessation trigger event";
  • "trigger events" should be objective;
  • market participants should use ESTER as the primary basis for a fallback rate;
  • fallback provisions should "minimize any potential transfer of value between parties when the fallback is applied by including a provision for an adjustment spread to be applied to the fallback rate";
  • any adjustment should be designed to eliminate or minimize "any potential transfer of value between parties when the fallback is applied and eliminate or minimize the risk of manipulation";
  • parties should consider provisions in agreements for new cash products, which would make it easier to modify the benchmark rate;
  • fallback provisions should be "consistent . . . across asset classes and/or product types, in particular in the case of related contracts"; and
  • market participants should develop "tailored fallback provisions to each specific product."

During 2019, the working group intends to offer more detailed fallback language for "legacy and new euro-denominated contracts."

Commentary / LaryStromfeld

The EU Benchmarks Regulation requires supervised entities to include in their client contracts, as of January 1, 2018, plans for IBOR transition. However, the recommended alternative, ESTER, may not be published until October 2019. The European Central Bank's guiding principles for fallback language for cash products is similar to the approach Cadwalader, Wickersham & Taft LLP helped the Federal Reserve Bank of New York's ARRC develop for USD LIBOR during this challenging transition period. Consistency across markets and products is a critical goal.

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