A two business-day "lag" period and five-year median credit-spread adjustments will be implemented.
The International Swaps and Derivatives Association, Inc. ("ISDA") has announced the results of its "Final Parameters" Consultation (the "Consultation") on a number of important mechanical details and specifications for interest rate swaps and other derivatives to be denominated in "(nearly) risk-free" overnight rates ("RFRs"). The Consultation sought further input from the market on the approaches to RFR-denominated swaps and London Inter-Bank Offered Rate ("LIBOR") transition that had been decided in prior consultations.
On the basis of the 90 responses to the Consultation, ISDA will (i) implement a two business-day back-shift or "lag" for payments to be calculated in arrears; and (ii) derive the "static" credit spread adjustment for each "tenor" from the median LIBOR-RFR spread over a five-year look-back period. ISDA will incorporate these specifications in the forthcoming amendments to the 2006 ISDA Definitions and "protocol" for British pounds, Swiss francs, Japanese yen, and Australian, Canadian, Hong Kong, Singapore, and United States dollars. (Parallel consultations on the euro are forthcoming.)
The two business-day lag is consistent with currently applicable conventions in the overnight index swap ("OIS") market and provides market participants breathing space between when a daily compounded amount can be calculated and when payment is due. Fifty-six percent of respondents preferred this approach over its chief competitor, a "freeze" period under which the RFR would be deemed to have been the same for the final few days of each Calculation Period.
The five-year look-back period for the credit-spread adjustments will be observed upon the occurrence of a transition "trigger" (i.e., the date LIBOR's administrator or regulator announces that LIBOR will no longer be published on a permanent or indefinite basis), with the resulting spread adjustments to be effective upon the date of actual cessation. The five-year look-back will by definition exclude the global financial crisis, but the median will measure all data-points including "outliers" and "inversions." Sixty-one percent of respondents supported this outcome.
The Alternative Reference Rates Committee ("ARRC") in the United States and other RFR working groups for cash products globally will undoubtedly take notice of these developments in the derivatives markets, but there is as yet no guaranty of alignment across products.