The Situation: The International Swaps and Derivatives Association ("ISDA") is in the midst of consulting the market on a wide variety of issues to develop "triggers" and "fallbacks" related to LIBOR cessation. Thus far, these and consultations by other industry groups have proceeded with a fair degree of consensus. However, ISDA announced its most recent consultation results on August 9, and the results were inconclusive.
The Result: ISDA issued the consultation, which concerned the inclusion of a "non-representativeness" trigger for transitioning away from LIBOR and other "at risk" IBORs, in May and set a July 12 "due date" for responses. The responses, none of which commanded a majority, fell into three categories: responses in support of the trigger, responses in support of a more flexible version of the trigger, and responses in opposition to the trigger.Looking Ahead:
ISDA will further analyze and issue a report on the consultation responses in September. ISDA also plans to accompany the report with a supplemental consultation on proposed "compromise" language that seeks to bridge the gap among responses. Any "non-representativeness" trigger will be included in ISDA's definitional amendments for prospective transactions and in ISDA's protocol for "legacy" transactions.
ISDA announced the results of its "pre-cessation trigger" consultation ("Consultation") on August 9. The Consultation proved to be somewhat controversial, and the results failed to produce a response with a clear majority.
The Consultation specifically addressed whether ISDA should include a pre-cessation trigger consisting of a "non-representativeness" declaration by the regulator (in the case of LIBOR, the United Kingdom's Financial Conduct Authority, or "FCA") for the relevant benchmark (again in the case of LIBOR, ICE Benchmark Administration Ltd., or "IBA"). FCA representatives have repeatedly outlined how they would intend (and indeed be required, under the European Union Benchmark Regulation and any equivalent post-Brexit legislation) to assess LIBOR's "representativeness" periodically, including biannually and upon each departure of a panel bank following the expiration of its commitment to the FCA to maintain LIBOR reporting through year-end 2021.
Edwin Schooling Latter (Director of Markets and Wholesale Policy at the FCA) and Andrew Bailey (head of the FCA) warned that, at some not-yet-specified point, the LIBOR panel is expected to have eroded to the point where LIBOR is no longer "representative" of the underlying market. This will, among other things, present significant practical and legal barriers to the execution of new LIBOR transactions and the maintenance of "legacy" LIBOR transactions. The Consultation was the immediate consequence of a letter to ISDA from Mr. Bailey and John Williams (president of the New York Fed) in their capacities as co-chairs of the Financial Stability Board's Official Sector Steering Group. The letter urged the adoption of a "non-representativeness" trigger for derivatives.
A "non-representativeness" trigger has also been included in all "cash product" (syndicated and bilateral loans, floating rate notes, and securitizations) recommendations to date from the Alternative Reference Rates Committee ("ARRC"). The ARRC is the private-sector committee for U.S dollar rates and associated products convened by the New York Federal Reserve with ex officio participation by many regulators, including the Commodity Futures Trading Commission and the Securities and Exchange Commission.
In the derivatives context, however, a "non-representativeness" trigger proved controversial. ISDA announced that the 89 responses fell into three groups, with none commanding a clear majority: responses in support of a non-representativeness trigger, those in support of a more flexible/optional trigger, and those in opposition to such a trigger. ISDA will seek to formulate a "compromise" solution for a supplemental market consultation in September that "attempts to account for and mitigate against the concerns expressed by respondents to the recent consultation [and] … seek[s] to avoid unnecessary complication and optionality, or anything that could jeopardize broad market adoption of the permanent cessation fallbacks."
The ARRC recommendations already diverge from ISDA's work in terms of their aspirations for "term SOFR" and the availability of "early opt-in" triggers that permits one or more transaction participants to initiate the process for replacing LIBOR when certain levels of similar activity in the relevant market are reached. ISDA and the ARRC, moreover, are on independent paths for the calculation "conventions" for "synthetic term" SOFR and for the requisite "credit spread adjustment" to equalize SOFR and LIBOR. Such "conventions" include overnight SOFR being averaged on a simple or compound basis and in advance or in arrears of the relevant interest period and the usage of "lag" or "lock-out" mechanisms. There is no guarantee ISDA and the ARRC will adopt the same conventions or calculate these figures in the same manner.
This latest controversy within derivatives further underscores the need for market participants to proceed with caution and to be aware of where and how LIBOR transition will converge and diverge for different products. Among other things, market participants should keep themselves fully apprised of the impact on their overall LIBOR exposures when considering LIBOR "fallback" language in cash products and derivatives, both for new transactions and for proposed amendments to "legacy" transactions. ISDA plans to publish a "protocol" in late 2019/early 2020 pursuant to which derivatives counterparties will be offered the ability to amend their derivatives transactions with other protocol "adherents" simultaneously. ISDA's definitional amendments and protocol will, of course, reflect the outcome of ISDA's continuing consultations on this and other issues.
Three Key Takeaways
- The responses to ISDA's "non-representativeness" trigger were inconclusive, with no clear majority in favor of any of three wildly divergent categories of response. ISDA plans to issue a supplemental consultation on proposed "compromise" language in September to see whether traction can be secured in favor of a single formulation of the trigger.
- This was the first of ISDA's consultations to secure less than a majority in favor of a single solution, and it potentially puts derivatives on a path at odds with the clearly expressed desires of regulators and with the cash market recommendations of the ARRC.
- Market participants must monitor developments such as this closely as, most immediately, they may influence the decision whether or not to adhere to ISDA's protocol (which is now scheduled to be released at latest early in 2020) and, once LIBOR transition triggers start to occur, the extent to which all products will transition at the same time.
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