ISDA has announced that it will launch the IBOR Fallbacks Supplement (the Supplement) to the 2006 ISDA Definitions and the ISDA 2020 IBOR Fallbacks Protocol (the Protocol) on 23 October 2020. The announcement has long been anticipated by market participants and reflects an important step in the IBOR transition for interest rate derivatives.
Market participants with significant derivatives exposures can now adhere to the Protocol in escrow on a non-public basis, although their adherence will not be effective until 23 October 2020. Although adherence to the Protocol is voluntary, regulators across the globe encourage regulated entities to sign up early in advance of the launch date on 23 October 2020.
The Supplement and the amendments made by the Protocol will take effect on 25 January 2021. On this date, all new (cleared and non-cleared) derivatives contracts that incorporate the 2006 ISDA Definitions and reference one of the covered IBORs will contain the new fallbacks. Derivatives contracts existing as of this date will incorporate the new fallbacks if both counterparties have adhered to the Protocol or otherwise bilaterally agreed to include the new fallbacks in their contracts. The Protocol will remain open for adherence after this effective date. Entities may adhere to the Protocol individually in their own capacity and/or as agents on behalf of clients, regardless of their domicile. Each market participant that intends to adhere to the Protocol should submit an adherence letter to ISDA. The IBOR fallbacks are based on adjusted overnight risk free rates, which will be calculated and distributed by Bloomberg in accordance with the IBOR Fallback Rate Adjustments Rule Book. These risk free rates will be compounded over the relevant IBOR period and a spread adjustment will be added to the compounded rate. The spread adjustment will be based on the median over a five-year period of the historical differences between the IBOR in the relevant tenor and the relevant risk free rate compounded over the relevant IBOR period, together providing a fallback rate for a derivatives trade referencing a covered IBOR.
With the clock ticking to the end of 2021, it is critical for market participants to consider how to move away from IBORs to risk free rates for each of their products referencing an IBOR. For interest rate derivatives, market participants should consider whether to adhere to the Protocol or to amend documentation on a bilateral basis. In addition to considering the desirable amendment procedures, it is important to establish a clear strategy to address internal and external communications, including interactions with clients, regulators and other stakeholders on the IBOR transition.
