ISDA IBOR Fallbacks
ISDA Overview
On 23 October 2020, the International Swaps and Derivatives Association (‘ISDA’) finalised a supplement to the 2006 ISDA Definitions (the ‘ISDA IBOR Supplement’) and published the ISDA 2020 IBOR Fallbacks Protocol (the ‘ISDA IBOR Protocol’). They both took effect on 25 January 2021.
The IBOR Fallbacks Supplement includes new contractual fallback provisions (‘ISDA Fallbacks’) that will take effect for derivatives contracts referencing in-scope IBOR rates (‘Covered Contracts’) upon certain index cessation events (‘ISDA Triggers’).
ISDA triggers are set
On 5 March 2021, the FCA announced that all LIBOR settings for all currencies will either cease or no longer be representative immediately after the following dates:
- 31 December 2021, for GBP, EUR, CHF and JPY LIBOR in all tenors, and USD LIBOR 1-week and 2-month; and
- 30 June 2023, for USD Overnight, 1-month, 3-month, 6-month and 12-month.
Following the FCA announcement, ISDA stated that this constituted an index cessation event (‘ISDA trigger’) for all 35 LIBOR settings. Therefore, the ISDA Fallbacks will automatically apply to covered contracts on the aforementioned trigger dates.
ISDA fallbacks
Covered Contracts will fall back to the RFR in the same currency (SONIA, SOFR, SARON, TONAR or €STR). The RFR will be adjusted by being compounded in arrears for the relevant term to reflect the fact that IBORs are term rates whereas RFRs are overnight rates. A fixed Spread Adjustment called five-year historical median will be added to that adjusted RFR, which is intended to reflect that IBORs include a degree of bank credit risk absent in RFRs.
Following the FCA announcement (see above), the five-year historical median spread adjustments for LIBOR in its five currencies and all settings were fixed as of Friday 5 March 2021. The final spread adjustments for each combination of currency and tenor have been published by Bloomberg.
ISDA IBOR Supplement
Upon the ISDA triggers, the ISDA Fallbacks will automatically apply to covered contracts incorporating the 2006 ISDA Definitions entered into from 25 January 2021.
ISDA IBOR Protocol
Derivative transactions incorporating the 2006 ISDA Definitions entered into prior to the Effective Date will not automatically include the new fallback provisions unless the parties agree otherwise.
ISDA has published the IBOR Fallbacks Protocol to enable parties to amend those existing derivative transactions as well as other specified documents which reference in-scope IBOR rates to include the updated rates and fallbacks.
If you do not adhere to the IBOR Fallbacks Protocol or otherwise bilaterally include robust fallbacks in derivatives documentation, existing fallbacks may not operate adequately or at all to allow parties to identify a fallback rate in the absence of a relevant IBOR.
Adhering to the ISDA 2020 IBOR Fallbacks Protocol
You should assess how IBORs are used in all your financial products and services with HSBC and any other counterparty as well as which of them would be covered by the IBOR Fallbacks Protocol. You should consult with your professional advisers on these changes as they can have economic and other impacts, including giving rise to potential mismatches between loans and derivatives or affecting any hedge accounting treatment applicable to those products.
By way of illustration, here are some implications of adhering to the IBOR Fallbacks Protocol:
- Mismatches may arise if a derivative transaction is used to hedge a product (e.g. a loan or a bond) which does not itself deal with the discontinuation of the relevant IBOR and the non-representativeness of LIBOR in the same way as the derivative transaction or at all (e.g. there are different trigger events or fallbacks).
- The new contractual fallback provisions may impact the commercial effect of non-linear interest rate derivative transactions (e.g. in-arrears swaps, certain cross-currency swap products, interest rate caps and floors and range accrual products).
- Adherence to the IBOR Fallbacks Protocol has the effect of an amendment to an existing ISDA Master Agreement or other covered agreement. You must ensure that you have obtained any required consent, approval, agreement, authorisation or other required action before signing up to or adopting the terms of the IBOR Fallbacks Protocol.
This article is a non-exhaustive summary for your information only and does not constitute any form of advice or recommendation.
We encourage you to read ISDA’s documents, together with the accompanying explanatory information on the ISDA website that will help you to familiarise yourself with the operation of the IBOR Fallbacks Supplement and the IBOR Fallbacks Protocol. You should also to seek guidance from your professional advisors on the possible implications of the changes outlined in this article for your business including financial, legal, accounting and tax impacts.
1 RFRs are typically backward-looking overnight rates based on actual transactions and reflect the average of the interest rates that certain financial institutions pay to borrow overnight either on an unsecured basis from wholesale market participants (for unsecured RFRs, such as SONIA) or the average rate paid on secured overnight repurchase or “repo” transactions (for secured RFRs, such as SOFR). RFRs do not include or imply any credit or term premium of the type seen in LIBOR or EURIBOR. However, RFRs are not truly free of risk. RFR’s can rise or fall as a result of changing economic conditions and central bank policy decisions.
2 Sterling LIBOR, Swiss Franc LIBOR, US Dollar LIBOR, Euro LIBOR, EURIBOR, Yen LIBOR, Yen TIBOR, Euroyen TIBOR, the Bank Bill Swap Rate, the Canadian Dollar Offered Rate, the Hong Kong Interbank Offered Rate, the Singapore Dollar Swap Offer Rate and the Thai Baht Interest Rate Fixing.
Frequently Asked Questions
The IBOR Fallbacks Protocol covers documents beyond those that incorporate or reference a rate defined in the 2006 ISDA Definitions. For instance, it covers transactions that incorporate or reference a rate in the 2000 ISDA Definitions. In addition to a range of ISDA published master agreements and credit support documents, it is important to note that the scope extends to agreements not published by ISDA, such as the Global Master Securities Lending Agreement or FBF Derivatives Master Agreements. However, the IBOR Fallbacks Protocol does not extend to every single master agreement (e.g. the German Master Agreement for Financial Derivatives Transactions).
The IBOR Fallbacks Protocol does not apply to documentation governing cleared transactions. You should refer to the relevant central counterparty for more information as to how the updates to the ISDA or other relevant documentation will affect transactions cleared with that central clearing house. CME has indicated that it intends to align with the ISDA documentation when including revised fallback language in its rules. In December 2018, LCH set out its position in respect of ISDA’s recommended benchmark fallback approaches, which has been followed by consultations on rulebook changes with its members.
Benchmark reform means that a number of benchmarks, particularly the IBORs, are being reformed and some benchmarks may no longer be available. If you do not adhere to the IBOR Fallbacks Protocol or otherwise bilaterally include robust fallbacks in derivatives documentation, existing fallbacks may not operate adequately or at all to allow parties to identify a fallback rate in the absence of a relevant IBOR.
An RFR, even with the addition of a spread adjustment, will not necessarily be a like-for-like replacement for the corresponding IBOR. This means that adopting or triggering the updated fallbacks in an existing derivative transaction may cause the value of the derivative to change. The final spread adjustments for each combination of currency and tenor have been published by Bloomberg.
Mismatches may arise if a derivative transaction is used to hedge a product (e.g. a loan or a bond) that does not itself deal with the discontinuation of the IBOR and the non-representativeness of LIBOR in the same way as the derivative transaction or at all. These mismatches could arise whether you adopt the terms of the IBOR Fallbacks Protocol or not, i.e. fallbacks in existing documentation may not currently match the hedged loan or bond. Mismatches could also affect the tax and/or accounting treatment of a product. Parties could consider bilateral amendments to exclude specific derivatives from the scope of the IBOR Fallbacks Protocol with the objective of matching the triggers and fallbacks in a hedged loan or bond. You need to consider for yourself, with your advisers, whether there may be a mismatch if you take any particular course.
While the terms of the IBOR Fallbacks Protocol will provide for a fallback rate for these products, you should consider whether the fallbacks set out in the IBOR Fallbacks Protocol would be commercially suitable for certain non-linear derivative transactions.
Adoption of the terms of the IBOR Fallbacks Protocol by both parties is effectively an amendment to an existing ISDA Master Agreement or other covered agreement. The IBOR Fallbacks Protocol also contains a representation to the effect that relevant consents have been obtained. If there are any consents required as a pre-condition of the amendment of any of your agreements covered by the IBOR Fallbacks Protocol, you will need to obtain those consents before you adopt the terms of the IBOR Fallbacks Protocol. If your obligations under the agreement or transaction have the benefit of any guarantee or credit support document and such documents require the consent, approval, agreement, authorisation or other action of a third party to be obtained in respect of any amendment, you must ensure that you have obtained such consent, approval, agreement, authorisation or other action before signing up to or adopting the terms of the ISDA Fallbacks Protocol.
If a security document is amended by the IBOR Fallbacks Protocol, you will need to consider whether to retake or re-register security interests as a result.
ISDA intends that the IBOR Fallbacks Protocol is for use without negotiation and a party will not be able to amend specific additional provisions, conditions or limitations when adhering. However, ISDA has published template language that enables parties to alter the scope of the IBOR Fallbacks Protocol. ISDA has also published forms of amendment agreements which enable parties to introduce the amendments contemplated by the IBOR Fallbacks Protocol without adhering to it.
HSBC Bank plc, The Hongkong and Shanghai Banking Corporation Limited, HSBC Bank USA, National Association and HSBC France, among others, have adhered to the IBOR Fallbacks Protocol. Other HSBC entities may adhere in the future. Therefore if you do decide to adhere to the IBOR Fallbacks Protocol, covered documents between you and these HSBC entities will be amended by the terms of the IBOR Fallbacks Protocol without further action between us.
Even though HSBC has decided to adhere to the IBOR Fallbacks Protocol, you will need to make your own assessment as to the impact of your adherence and the steps you should take in advance of adhering or adopting the terms of the IBOR Fallbacks Protocol.
If you do decide to adhere to the IBOR Fallbacks Protocol, your adherence will result in amendments to covered documents that you have entered into with other adhering parties. You will therefore need to consider the impact of your adherence in the context of covered documents you may have entered into with other adhering parties.
We encourage you to read ISDA’s documents, together with the accompanying explanatory information on the ISDA website that will help you to familiarise yourself with the operation of the IBOR Fallbacks Supplement and the IBOR Fallbacks Protocol. Where your transactions are entered into with HSBC Bank plc or HSBC Bank USA, National Association, you should also read the ISDA’s IBOR Alternative Reference Rates Disclosure Annex.
HSBC Group makes no representation or warranty with respect to the accuracy or completeness of this document. Unless agreed otherwise or required by applicable law or regulation, we are not providing any advice or recommendation or offering any product or service in this document nor are we assuming any responsibility to provide advice. Any action that you take (or fail to take) in relation to the IBOR Fallbacks Protocol is your own decision and we assume no liability in relation to this. As the content of this document is complex, we would encourage you to read the documents published by the International Swaps and Derivatives Association thoroughly and obtain any professional advice as you may deem necessary or appropriate for your specific circumstances.
Except in the case of fraudulent misrepresentation, no liability is accepted whatsoever for any direct, indirect or consequential loss arising from the use of this document. HSBC is under no obligation to keep current the information in this document. Neither HSBC nor any of its affiliates are responsible for providing you with legal, tax or other specialist advice and you should make your own arrangements in respect of this accordingly. This is not a financial promotion. Unless governing law permits otherwise, you must contact a HSBC Group member in your home jurisdiction if you wish to use HSBC Group services.
Last updated: 16 March 2021