On Tuesday February 25, the International Swaps and Derivatives Association, Inc. (ISDA) launched its new consultation seeking input on whether its forthcoming Supplement to the 2006 ISDA Definitions (the Definitions) should amend the rate options for LIBOR (in all of the relevant currencies, including USD and GBP) such that fallbacks would be triggered not only upon the permanent cessation of LIBOR, but also if the UK Financial Conduct Authority (FCA) (the regulator of benchmarks in the UK) were to announce LIBOR is no longer a representative rate. Such an announcement, if it were to occur prior to permanent cessation, would trigger a "non-representative" pre-cessation event (the Consultation).1

As market participants are aware, panel banks will no longer be compelled to submit LIBOR rates following the end of 2021. There is an increasing expectation in the market that a pre-cessation event (such as an FCA announcement indicating non-representativeness) will occur prior to the permanent cessation of the publication of LIBOR. This could lead to a scenario where LIBOR continues to be published, but does not provide a representative rate to the market (such rate has been dubbed "zombie LIBOR"). This potential scenario has prompted regulators to request ISDA to gain further clarity on market preferences in this scenario and potentially include this as a reference rate fallback trigger in its anticipated protocol (the Protocol).

Regardless of the results of the Consultation, ISDA will publish the Protocol which has been under development by an ISDA working group for some time to address benchmark fallbacks both in existing documents and in legacy contracts. If the responses to the Consultation meet the required criteria for positive respondents (as determined by ISDA and as set out in the Consultation), then the Protocol will allow parties to reference the amended Definitions which will reflect both permanent cessation and pre-cessation triggers in all of their legacy contracts with other adherents.

If there is an insufficient positive response to the Consultation according to ISDA's criteria (as set out in the Consultation), the Protocol will reflect the following:

The Supplement and Protocol to implement the permanent cessation fallbacks. Amendments to the Definitions (as part of the Supplement) to allow market participants to incorporate pre-cessation fallback provisions in their new derivatives (in addition to the permanent cessation fallbacks) if they choose to do so. An "annex" to the Protocol to allow market participants to "opt-in" to the pre-cessation fallback provisions with counterparties who also opt-in to those fallback provisions as part of their adherence to the Protocol implementing the permanent cessation fallbacks.

As ISDA has noted in its publications, parties are, of course, not obligated to use the Protocol; bilateral amendments are always an alternative.

Background to the Consultation

ISDA published the results of its initial consultation from 2019 on pre-cessation fallbacks in October 20192 (the First Pre-Cessation Consultation), which followed a request by the Financial Stability Board’s Official Sector Steering Group (FSB OSSG) in March 2019 for ISDA to obtain market feedback on the events that should trigger a move to a spread-adjusted fallback rate for LIBOR.3 The results of the First Pre-Cessation Consultation, however, did not reflect market consensus on implementation of pre-cessation fallbacks, including whether the permanent cessation fallback rates should apply following a non-representativeness determination. As such, ISDA is (and likely many market participants are) hoping that the Consultation will build a consensus on how to implement pre-cessation fallbacks.

ISDA has been working with the FSB OSSG since 2016 to identify robust fallbacks for derivatives contracts that reference certain key IBORs, including (USD and GBP LIBOR). Following the failure of the First Pre-Cessation Consultation to achieve market consensus on implementation of pre-cessation triggers, in November 2019, the FSB OSSG requested that ISDA4 include a pre-cessation trigger alongside the permanent cessation trigger as standard language in the amended Definitions for new derivatives and in the Protocol, which would address legacy contracts.

In response to the FSB OSSG request, ISDA has continued to work towards finalizing fallbacks that take effect following a permanent cessation of LIBOR, while also working with regulators and the industry to increase market understanding of the implications of a non-representative LIBOR, including through publication of the Consultation.

EU Benchmarks Regulation

It is important to note that the law governing critical benchmarks such as LIBOR is set out in the European Union Benchmarks Regulation (the BMR).5 The BMR regulates benchmark administrators; ICE Benchmark Administration is the current administrator of LIBOR. Under the BMR, supervised firms that use LIBOR as a benchmark must have appropriate plans in place in the event that a benchmark materially changes or ceases to be provided. Currently, market participants who are supervised firms have been relying on the ISDA Benchmark Supplement Protocol for their derivatives contracts.

In addition, under the BMR, once the benchmark becomes non-representative, the administrator must cease to provide the benchmark within "a reasonable time period." This gives some assurance to the market, including the derivatives market, that unrepresentative LIBOR rates will not continue for an unreasonable length of time.6 However, there remains ambiguity around what would be viewed as "a reasonable time period."

Next steps

The deadline for responses to the new consultation is March 25, 2020. ISDA aims to publish the results of this consultation, alongside information on next steps, in late April or early May.