On November 2, 2017, the International Swaps and Derivatives Association (ISDA) announced that its planning process for transitioning financial contracts away from LIBOR and to the new alternative risk-free-rates is underway.
ISDA’s announcement is welcome news, following the UK Financial Conduct Authority (FCA) chief executive’s statement earlier this year that the FCA would no longer require banks to participate in LIBOR after 2021. The FCA CEO effectively put market participants on notice: find a new financial benchmark, and stop relying on LIBOR. By January 1, 2022, swap counterparties, lenders, borrowers, debt issuers, and all other market participants that enter into contracts referencing LIBOR will need to (i) amend their existing contracts that extend past 2021 to include a “LIBOR fallback,” (ii) draft revised benchmark terms to be incorporated into new contracts, and (iii) implement a basis risk mitigation plan for the inevitable spread between LIBOR and the new reference rate.
While 2022 may seem far off, transitioning the entire multi-trillion-dollar derivatives market to a new financial benchmark is a vast undertaking. The first part of ISDA’s plan entails a comprehensive analysis of the use of LIBOR (and other interbank rates) in various financial markets, and a survey of market participants to determine the most efficient method for transitioning away from LIBOR. Once the survey results are in and the analysis is complete, ISDA plans to outline a roadmap of its proposed solutions, along with an implementation timeline.
Although ISDA is best known as the voice of the derivatives industry, and for creating industry-standard derivatives documentation (e.g., the ISDA Master Agreement), the organization’s post-LIBOR transition plan appears to be much broader in scope. In discussing its process, ISDA’s chief executive stated that ISDA is working at a “global level” and “it is fundamental that any potential solutions take into account the interconnectedness of the markets,” meaning ISDA’s transition solutions may apply to mortgages, bonds, and loans – not just derivatives.
In response to sweeping regulatory changes in the past, ISDA has created “protocols” that allowed adhering swap counterparties to efficiently amend the terms of all existing agreements between them (without having to go through the painstaking process of amending each contract manually). We expect that ISDA will prepare an analogous solution to the LIBOR transition problem, though the exact timeline of when such a protocol would be available and to which contracts it would apply is as yet unclear.
What we do know is that ISDA expects to publish the results of its cross-market survey, its roadmap of proposed solutions, and its implementation timeline in early 2018. Around the same time (by mid-2018), the Federal Reserve Bank of New York will begin publishing a new reference rate – the Secured Overnight Financing Rate (SOFR), which was chosen as the preferred successor to USD LIBOR by the Alternative Reference Rate Committee. At present, much remains uncertain about the transition away from LIBOR, but the pieces of the puzzle may begin to fall into place later next year.
Do you have questions about how your company, bank, or fund should be preparing for the end of LIBOR? Please contact the authors of this legal alert, who can assist with any large documentation projects stemming from the transition to a new financial benchmark.