Replacing IBORs in derivatives: there’s a protocol for that

This article was written by Max Allan, Dale Rayner, Claire Warren and Dominic Atwell-Harris.

Ahead of the expected cessation of the London Inter-bank Offered Rate (LIBOR) at the end of 2021, along with the possible discontinuance of other key inter-bank offered rates (IBORs), the International Swaps and Derivatives Association (ISDA) has announced it will launch the ISDA 2020 IBOR Fallbacks Protocol (Protocol) and the IBOR Fallbacks Supplement to the 2006 ISDA Definitions (Supplement) on 23 October 2020, with the Supplement and the amendments made by the Protocol to take effect on 25 January 2021. 

On that date, ISDA notes that all new derivatives contracts incorporating the 2006 ISDA Definitions and referencing one of a range of covered IBORs will contain new fallbacks to adjusted versions of risk-free rates should the relevant IBOR benchmark becomes unavailable, if both counterparties have adhered to the Protocol or otherwise bilaterally agreed to include the new fallbacks in their contracts.

Following ISDA's announcement of the launch date of the Protocol and the Supplement, the Australian Securities and Investments Commission (ASIC), the Australian Prudential Regulation Authority and the Reserve Bank of Australia (RBA), jointly announced that "all financial and corporate institutions that use derivatives contracts referencing LIBOR are strongly encouraged to review and adhere to the protocol by its effective date". This echoes similar announcements by the Financial Stability Board and the Bank of England. Additionally, ASIC Commissioner Cathie Armour stated that the Protocol is an important step towards the orderly transition of billions of dollars' worth of financial contracts in the derivatives market, declaring that industry-wide adoption will significantly reduce the risks of contractual disputes, litigation and frustration. 

The transition away from LIBOR and other key IBORs including the development of new fallbacks to these rates raises important considerations for market participants and a number of key internal decisions will need to be made in choosing the right path to follow.  Market participants will need to consider how LIBOR cessation affects all areas of their business and to consider their preferred approach to transitioning away from reliance on LIBOR rates, which may differ across product or business lines. However, with the launch of the Protocol and the Supplement, hopefully answering some of these questions may now prove a little easier.

Please don't hesitate to reach out if you have any particular queries or would like to discuss the Protocol, the Supplement or IBOR transition more generally.  We look forward to speaking with you.  Also keep an eye out for developments in the cash markets which we expect will be informed by the response to the Protocol.