GovernanceRegulationIsda: Firms must push “active transition” ahead of Libor cessation

Isda: Firms must push “active transition” ahead of Libor cessation

Derivatives market participants must begin to rely on fallback rates, Isda’s head of benchmark reform contracts told a conference this week.

“Firms really need to think about active transition,” said Ann Battle. “Having robust fallbacks is a vital step. It is a safety net.”

On January 25, Isda’s Ibor fallbacks came into effect for any contract referencing the standard interest rate derivates definitions.

Based on Risk-Free Rates (RFRs), the fallbacks include spread adjustments to reduce the chance or contract diverging too far from counterparties.

Battle said the work of the Alternative Reference Rates Committee (ARRC) and other working groups has shown that RFRs are arguably the most suitable rates for derivatives.

The fallback mechanism made available by regulators means market participants can use the RFRs to design a “safety net” and provide further clarity within their legal contracts.

“That does not mean that you then have to live through the event as described in the definition. It puts you in a safer position, then you can go appropriately discuss and negotiate with your counterparty,” said Jason Granet, managing director and head of Libor transition at Goldman Sachs.

“There’s massive momentum underway here,” said Scott O’Malia, CEO at Isda. “By the end of 2023, so many of these US Libor trades are going to be rolling off. Libor’s days are numbered.”

On March 5, the UK’s Financial Conduct Authority (FCA) confirmed the cessation of Libor immediately after December 31, 2021, for sterling, euro, Swiss franc and Japanese yen settings, as well as the one-week and two-month US dollar settings. The remaining settings under US Libor must be ceased immediately after June 30, 2023.

Regulated firms should focus on the operational transition by increasing the usage of alternative rates and must not use the interbank rate for any new contract this year now that they have nine months until the discontinuation of Libor.

“The biggest challenge to this point has been getting contractual terms. Now we have to execute what is in the contract. The shift has gone from getting the terms right to operationalising set terms,” said Granet.

Randal K Quarles, the Federal Reserve’s vice chair for supervision, echoed the need to cease any Libor-based settings.

“These announcements are absolutely not meant to support new Libor activity or continued business as usual. Instead, they are meant to completely end the new use of Libor while allowing a significant portion of legacy contracts to roll off before the key dollar Libor tenors stop publication,” he said at an event held by the ARRC yesterday.

In January, RFR-linked Interest Rate Derivatives (IRD) DV01 increased to $2.9bn compared to $2.4bn the prior month, marking a slight uptick of the fallback protocol, according to ISDA.

In a report published on March 22, ARCC highlighted the “tremendous progress” made in transitioning away from the US dollar-based Libor within the last year but revealed that there remained products, including business loans, that had not ceased the usage of the interbank rate.

From the end of March, the ICE Benchmark Administration will cease the publication of all sterling Libor settings – a deadline that Granet deems “realistic.”

“The market has had very strong movement and transition for a long period of time. It’s an inevitability,” he added.

The deadlines published by the FCA will also enable market participants to navigate tough legacy issues appropriately. As protocols and fallback languages are adopted, the market is able to “pin down” what is true around trough legacy, according to Granet.

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