Disclosure relating to transactions which reference LIBOR
Published on 29 March 2021
On March 5, 2021 the Financial Conduct Authority (“FCA”) announced that:
The FCA stated that, therefore, all thirty-five LIBOR settings will either cease to be provided by any administrator or no longer be representative after the dates set out above.
If USD/GBP/JPY/CHF/EUR LIBOR (as relevant) is discontinued during the term of your transaction with us, the contractual terms may provide a process for determining a fallback but it could be unclear and uncertain what rate your transaction would reference as a result of this process. In addition, contracts relying on LIBOR may not perform as expected, both when LIBOR ends and potentially before that. One potential reason for this is that liquidity in LIBOR-referencing products is likely to decline.
Due to this lack of clarity and certainty you may be disadvantaged economically. Timing for any discontinuation of LIBOR will vary across different currencies and tenors in which LIBOR is currently produced (as set out above) and such timing may differ from the timing for any discontinuation of other interbank offered rates (IBORs). In addition, the discontinuation of LIBOR may result in a mismatch between the rate referenced in your transaction and your other financial instruments, including, potentially, those instruments intended as hedges, and loans which your transaction is intended to hedge.
The International Swaps and Derivatives Association, Inc. (ISDA) has amended certain ‘floating rate options’ in the 2006 ISDA Definitions to include fallbacks that would apply upon the permanent discontinuation of certain key IBORs and upon a ‘non-representative’ determination for USD/GBP/JPY/CHF/EUR LIBOR. ISDA also amended certain floating rate options that use USD LIBOR as an input to include fallbacks that would apply if USD LIBOR is permanently discontinued or upon a ‘non-representative’ determination for USD LIBOR. As it has done from time to time, ISDA amended the 2006 ISDA Definitions by publishing a ‘Supplement’ to the 2006 ISDA Definitions which came into effect on 25 January 2021. The Supplement amends ISDA’s standard definitions for interest rate derivatives to incorporate fallbacks for derivatives linked to certain IBORs. Transactions incorporating the 2006 ISDA Definitions that are entered into on or after 25 January 2021 include the amended floating rate option (i.e., the floating rate option with the applicable fallback). Transactions entered into prior to 25 January 2021 (so called “legacy derivative contracts”) continue to be based on the 2006 ISDA Definitions as they existed before they were amended pursuant to the Supplement, and therefore will not include the amended floating rate option with the Supplement’s applicable fallback unless they are separately amended (e.g. by bilateral agreement or the ISDA Protocol described below).
ISDA has published the protocol (ISDA Protocol) to facilitate multilateral amendments to include the amended floating rate options, and therefore the fallbacks, in legacy derivative contracts which are covered by the ISDA Protocol.
By adhering to the ISDA Protocol, market participants agree that their legacy derivative contracts which are covered by the ISDA Protocol with other adherents include the amended floating rate option for the relevant IBOR and therefore include the applicable fallback. As always, the ISDA Protocol is completely voluntary and amends contracts only between two adhering parties (i.e., it does not amend contracts between an adhering party and a non-adhering party or between two non-adhering parties). The fallbacks included in legacy derivative contracts that incorporate the 2006 ISDA Definitions by adherence to the ISDA Protocol are equivalent to the fallbacks included in new transactions that incorporate the 2006 ISDA Definitions and that are entered into on or after 25 January 2021. While both the Supplement and the ISDA Protocol cover various LIBORs and key IBORs, there are some IBOR rates for which they do not give fallbacks.
If the new fallbacks do not apply to your derivative transaction, to manage the lack of clarity regarding the rate that your transaction would reference upon the discontinuation of USD/GBP/JPY/CHF/EUR LIBOR, you may wish to consider either:
ISDA has published a table that summarises how the IBOR fallbacks apply to a variety of products, including vanilla interest rate swaps, cross-currency swaps, range accruals, caps and floors, amongst others. That document also contains detailed description of how the fallbacks interact with certain non-linear products, along with template language which parties can use if they voluntarily choose to bilaterally negotiate changes to certain terms. The table can be found here. Additionally, whilst the ISDA Protocol published by ISDA can be used to amend transactions referencing a key IBOR entered into under a range of different documents (not just those entered into under an ISDA Master Agreement), it is not intended to be comprehensive and it does not amend the terms of new transactions entered into on or after 25 January 2021 (or before you adhere to the ISDA Protocol if that is later than 25 January 2021).
If LIBOR is discontinued during the term of your transaction and the ISDA fallbacks have been incorporated, your transaction would reference an adjusted version of SOFR/SONIA/TONA/SARON/€STR, a rate that is inherently different from LIBOR. As a result, payments would be calculated differently and you may be disadvantaged economically. LIBOR is a forward looking term rate that is meant to represent a bank’s cost of funding over various tenors, whereas each of SOFR/SONIA/TONA/SARON/€STR is an overnight nearly-risk free rate and the relevant adjustments will not perfectly account for these differences on an ongoing basis.
It should be additionally noted that the new ISDA fallbacks may be different from the fallbacks implemented in your other financial instruments. As such the discontinuation of LIBOR may result in a mismatch between the rate referenced in your transaction and your other financial instruments, including potentially those instruments that are intended as hedges, and loans which your transaction is intended to hedge (even if the hedged instruments contain updated fallback provisions, unless those provisions are based on the fallbacks in the 2006 ISDA Definitions).
You should review the terms of your transaction and your other financial instruments to determine if adhering to the ISDA Protocol or entering into appropriate bilateral amendments will meet your hedging and/or other objectives. You should also consider the legal, tax, accounting, commercial and regulatory implications of executing and then potentially amending your transaction. As nothing in this document should be taken to be advice, we encourage you to seek independent advice on these matters.
For more information on benchmark reform related to LIBOR and other IBORs, as well as specific information about the relevant rates, see https://www.isda.org/2020/05/11/benchmark-reform-and-transition-from-libor/
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