FSB Encourages ISDA to Consult on Third LIBOR Trigger and Parameters of Spread Methodology

The heads of the UK Financial Conduct Authority and the Federal Reserve Bank of New York, acting as co-chairs of the Financial Stability Board's ("FSB") Official Sector Steering Group ("OSSG"), encouraged ISDA to seek market feedback on the addition of a third "trigger event" in fallback language that would trigger derivatives referencing IBOR floating rates to move to the adjusted alternative rate. ISDA has indicated that it would seek feedback for IBORs that were the subject of its now-closed July 2018 Consultation, and is considering adding a "pre-cessation" event in its upcoming consultation on USD LIBOR and other IBORs not included in its earlier Consultation.

The OSSG co-chairs noted, "Without a trigger for this event included in the ISDA definitions, market participants could find themselves forced either to continue using LIBOR in legacy contracts within a severely disrupted market or agree bilaterally on terms at which they could close out across a wide array of contracts and counterparties, which would likely be difficult."

The OSSG co-chairs also encouraged transparency by ISDA's Board Benchmark Committee for the technical details being developed with regard to the spread adjustment of risk-free rates (such as the Secured Overnight Financing Rate), including "the parametrisation of the historical mean/median look-back, and the details of how the credit spread will be calculated and applied over the compounded rate."

Commentary

ISDA has led the development of more robust language in contracts for new derivatives transactions regarding the move to the adjusted alternative risk-free rates upon the occurrence of certain trigger events. These trigger events are based on a permanent or indefinite cessation of LIBOR. Fallback language being developed in Alternative Reference Rates Committee working groups for cash products includes one or more additional "pre-cessation" events that are designed to address illiquidity or other concerns about LIBOR prior to a permanent cessation. Any difference in trigger events increases the basis risk between cash products and related hedges. Inclusion of a pre-cessation trigger in standard derivatives documentation will help narrow the gap.

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