Recommendations for contracts linked to a now-defunct reference rate – and which will no longer be of use after June 2023 – were issued Wednesday by a Federal Reserve-sponsored group that developed an alternative rate.
The Alternative Reference Rates Committee (ARRC) said it released recommendations for contracts linked to U.S. dollar London Interbank Offered Rate (USD LIBOR) ICE Swap Rates (ISR). According to the ARRC, a group convened in 2014 by the Federal Reserve Board and the Federal Reserve Bank of New York, and which developed the LIBOR alternative Secured Overnight Financing Rate (SOFR), the recommendations recognize that the contracts are not covered by federal legislation enacted last spring and that counterparties may need to take proactive steps to address the end of the USD LIBOR ISR.
(The legislation, enacted as part of the Consolidated Appropriations Act of 2022, was aimed at establishing a uniform, nationwide process for replacing LIBOR in existing contracts, “the terms of which do not provide for the use of a clearly defined or practicable replacement benchmark rate, without affecting the ability of parties to use any appropriate benchmark rate in new contracts.”)
The committee noted that contracts referencing the USD LIBOR ISR include USD LIBOR swaptions, USD LIBOR Constant Maturity Swap (CMS)-linked derivatives, and certain debt instruments.
“To avoid disruption to these contracts, the ARRC developed a set of recommendations including a suggested fallback formula that can be used for USD LIBOR ISR fixings after 3-month USD LIBOR has been discontinued or becomes non-representative,” the ARRC said.
Recommendations released by the committee include:
- Market participants should inventory their contracts tied to the USD LIBOR ISR and identify the fallback provisions that they contain. For contracts whose primary fallback is a dealer poll, particular attention should be paid to the secondary fallback, i.e. the fallback that would apply if the dealer poll(s) were to fail.
- Where practical, market participants should take proactive steps to address the impact of the cessation of USD LIBOR ISR on their legacy positions (e.g. USD LIBOR swaptions, USD LIBOR CMS-linked derivatives and debt instruments) by:
- Converting these positions to their SOFR or SOFR ISR equivalent, or
- Incorporating hardwired fallbacks consistent with the approach suggested by the ARRC and included in the prevailing version of the ISDA Definitions, or
- Considering calling or buying back debt instruments with problematic fallback provisions.
- If a legacy position cannot be proactively converted to SOFR or the SOFR ISR and its contractual fallbacks cannot be amended:
- The ARRC believes that, once 3-month USD LIBOR has ceased to be published as a representative rate, the fallback formula suggested would accurately represent the at-the-money rates of standard interest rate swaps which are tied to it and which incorporate the fallback provisions introduced in the ISDA 2020 IBOR Fallbacks Protocol.
- As a result, if the contractual fallbacks involve calculation agent determination, the ARRC recommends that calculation agents consider the ARRC’s suggested fallback formula in determining a successor rate.