On 5th March 2021, the Financial Conduct Authority (“FCA”) confirmed that the publication of the majority of LIBOR currencies will cease on 31st December 2021[1].  This announcement will be of no surprise to a financial services industry that is knee deep in LIBOR transition, but it does provide concrete timelines, with a shift in focus to what firms are doing to operationalise fallbacks.

As Scott O’Malia, chief executive of ISDA, pointed out, this announcement means that users now have firm dates to apply to the fallback rates that had been created to ensure a smooth transition to the new rates. 

This blog aims to summarise what firms should be thinking about when it comes to the operationalisation of fallbacks.

What is a fallback and what role does it play in LIBOR Transition?

A fallback rate is a contractual provision to find a replacement rate if the contractual rate is not available. However, historically, fallback language has only been needed when a rate becomes temporarily unavailable and was not intended to cover the permanent cessation event that was announced on 5th March 2021.

The cessation of the majority of LIBOR rates in 2021 will require widespread use of fallbacks across all product sets.  In October 2020, specifically for derivatives markets, ISDA published its ISDA IBOR Fallbacks Supplement & 2020 Fallbacks Protocol, which took effect on 25th January 2021.  In the simplest terms, the Protocol provides a mechanism for counterparties that have adhered to it, to apply the same fallback provisions to legacy transactions.  Adherence to the Protocol is voluntary but it will no doubt provide derivatives market participants with much needed standardisation. There are approximately 13,500[2] counterparties currently adhering to the protocol.

To amend or not amend?

One of the key challenges for institutions has been deciding what approach to take when it comes to the handling of legacy derivatives transactions.  Back in 2018 when LIBOR Transition Programmes were beginning to blossom, the general consensus was that legacy transactions would be amended from LIBOR to the relevant fallback rate, in what would simply be, a trade amendment.  The key challenge, many thought, would be the ability for systems to handle the huge volume of trade amendments that would come through. Fast-forward 18 months, and since the Protocol was published, ISDA has provided important guidance:

 “If the permanent cessation fallbacks are triggered and apply, the terms of the confirmation will remain exactly the same…”[3]

In one sweep, the original concerns have been addressed, as trade amendments look to be off the table. If a contract references GBP LIBOR today, then on 1st January 2022 it should continue to reference GBP LIBOR but the pricing source of GBP LIBOR will move to the Bloomberg fallback rate for SONIA.

The clock is now ticking to find an alternative method to a ‘simple’ cancel/ rebook, in order to ensure that the price sourcing reflects the Bloomberg fallback rate without compromising the original terms of the trade.

Upcoming Challenges

Once a solution is found to support fallback rates without amending trade terms, there will need to be considerations for the front to back flow.  Further, it will be important to consider the wider impact of not changing the trade terms on other downstream processes, which may need to see the economic rate of the trade.  Without a change in the rate on the trade itself, how will backend systems know what the “true” economic rate of the trade is? 

In our view, the key challenge will be in regards to transaction reporting to different jurisdictions; currently there is limited guidance from global bodies regarding how trades that have fallen back should be treated from a reporting perspective.  An inconsistent view across reporting regimes will add pressure to what is already a busy 2021 for LIBOR Transition Programmes and ultimately if trade terms are not being amended it will be challenging to find a solution to report trades as required. 

Conclusion

The execution of work needed to operationalisation fallbacks is picking up pace, but there will still be many challenges to come as firms work through the much needed development work to support the ISDA guidance, as well as dealing with the downstream reporting impacts.  We also expect regulators to start probing firms more on what their plans are to support this work so firms should be prepared to detail their plans.

If you would like to hear more from your peers on this topic, then please do join us for our next LIBOR Operations Forum where this will be discussed in further detail along with other key topics. Please contact Gwun Olley for more details.

[1] https://ir.theice.com/press/news-details/2021/ICE-Benchmark-Administration-Publishes-Feedback-Statement-for-the-Consultation-on-Its-Intention-to-Cease-the-Publication-of-LIBOR-Settings/default.aspx

[2] https://www.isda.org/protocol/isda-2020-ibor-fallbacks-protocol/adhering-parties - as of 12th March 2021, 13,534 counterparties had adhered to the Protocol.

[3] ISDA Benchmark Reform at a Glance: http://assets.isda.org/media/84188f8a/393ce991-pdf/