Contractual fall-backs

There are fundamental differences between LIBORs and RFRs. For example, RFRs are overnight rates, while LIBORs are available in multiple tenors. Additionally, LIBORs incorporate a bank credit risk premium while RFRs do not. As a result of these differences, both term and spread adjustments to the applicable fall-back RFRs are required to ensure that contracts referencing LIBOR will continue to function as closely as possible to the original agreement, in the event that the fall-backs are activated.

The proposed fall-back clauses incorporate mechanisms for making the required term and spread adjustments and also define the ‘trigger’ that ends the contractual reference to LIBOR and ‘switches’ to the relevant fall-back adjusted RFR.

The International Swaps and Derivatives Association (ISDA) had stated that it plans to amend the 2006 ISDA Definitions through publishing a supplement. This is expected to incorporate the adjusted RFRs as the fall-backs for all new LIBOR referencing derivatives contracts that utilise those Definitions post the effective date of the supplement1.

ISDA also intends to publish a voluntary protocol to allow for the insertion of these amended 2006 ISDA Definitions into all legacy derivatives contracts between parties that adhere to the protocol.

ISDA selected Bloomberg to calculate and publish adjustments related to RFR fall-backs that ISDA intends to implement. The publication of indicative fall-back rates commenced in July 2020.

Industry bodies for other asset classes, such as the loan market, are considering similar approaches to contractual fall-backs in their documentation. Fall-backs may have differences across different product types and asset classes. Therefore, there may be a potential mismatch in replacement rates across products in your portfolio2.

Things you should know

1 The fall-backs would apply to a number other ‘IBORs’, as well – we refer to isda.org for details.

2 So-called ‘triggers’ that end the contractual reference to LIBOR and ‘switch’ to the relevant fall-back adjusted RFR may vary as well.

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