The co-Chairs of the Financial Stability Board’s Official Sector Steering Group, whose work focuses on interest rate benchmarks that are deemed to play a critical role in the global financial system, have written to the International Swaps and Derivatives Association requesting that it includes a “pre-cessation trigger” alongside the cessation trigger in its standard language in derivatives contracts, via either definitions for new contracts or in a single protocol (without embedded optionality) for outstanding contracts. The pre-cessation trigger would cause a LIBOR-based contract to fall back to an alternative reference rate in the event that the U.K. Financial Conduct Authority, as the regulator of LIBOR, deemed that LIBOR was no longer representative. ISDA consulted in May on the introduction of a pre-cessation trigger and reported that the majority of respondents supported the move, but that there were differing views on how it should be implemented. ISDA has not published any pre-cessation trigger language and the co-chairs of the OSSG – Andrew Bailey, CEO of the FCA and John Williams, CEO of the Federal Reserve Bank of New York – are urging ISDA to take further steps, if necessary, to do so.
The OSSG’s letter notes that, while the two largest central counterparties intend to move cleared derivatives contracts away from LIBOR in the event of a “non-representative” determination by the FCA, no similar trigger exists for uncleared contracts. This could cause a discrepancy in rates between cleared and uncleared contracts, with potential market fragmentation ramifications. The OSSG recommends that ISDA includes standard pre-cessation trigger language alongside the cessation trigger in its definitions for new derivatives and via a single protocol that would incorporate such language into outstanding contracts. The OSSG also advises against “opt-in” or “opt-out” alternatives as this would present additional complexity and risk management challenges, but notes that parties could still agree to bilaterally amend the pre-cessation and cessation triggers.