ISDA on Friday published its fallback protocol for the cessation of IBOR. It didn’t contain anything materially new but it did confirm specific dates and calculation methodologies which it has been working on for over a year in consultation with working groups.
As of 25th January 2021, the fallbacks will be incorporated into the terms of any new derivative transactions. Legacy cleared trades will automatically adopt the fallbacks by way of clearing house rules, and any bilateral non-cleared trades will have standardised documentation available to amend those trades with active bilateral agreement. The fallback methods themselves will be based on the new risk free rates (RFRs) in each currency, such as SOFR, ESTR and SONIA, compounded over the respective IBOR tenor with a credit spread adjustment.
We have seen increased interest from firms looking to begin or enhance their IBOR transition preparedness. For Nordic firms those most in need of active project management are those with EUR or USD funding and/or cross currency swaps, whose valuation and cashflows depends on an IBOR based index. Transition projects can be quite complex, involving remapping of internal funding curves, and risk factors for VaR, ensuring bilateral agreements are in place, updating IFRS9 accounting relationships, etc..
While we have not yet had any IBOR cessation announcements, webinars, such as those hosted at Risk.net, have speculated that earlier announcements may well be preferable with just over a year until the target deadline at end 2021. It is unclear what will happen to IBOR after these dates but there has been continued momentum for RFRs as clearing houses switched to ESTR as the remuneration rate for EUR collateralised derivatives over the summer and this month switched to SOFR for USD collateralised derivatives.
ISDA also released their review of the transition to RFRs for the third quarter. They highlight that the adoption index and trading volumes broadly doubled over the period. We anticipate that even this pace of expansion will continue to grow toward the end of the year and as potentially the last ever year of LIBOR begins.