In September 2018, the International Swaps and Derivatives Association
(ISDA) published the ISDA Benchmarks Supplement as a response to the EU
Benchmarks Regulation (BMR), which regulates the use of benchmarks.
The term “benchmarks” is broadly defined as any index that
is used to (a) determine the amount payable under a financial contract or
financial instrument, which includes derivatives contracts; (b) determine
the value of a financial contract or financial instrument; or (c) measure
the performance of an investment fund with the purpose of tracking the
return of such index or of defining the asset allocation of a portfolio or
of computing the performance fees.
The ISDA Benchmarks Supplement allows entities to amend the contractual
triggers and fallbacks of over-the-counter (OTC) derivatives documentation
that references interest rate, foreign exchange, equity and commodities
benchmarks under the current ISDA definitions incorporated into
transactions using the ISDA Master Agreement and associated documentation.
ISDA Benchmarks Supplement
The ISDA Benchmarks Supplement includes fallbacks that apply if (i) a
benchmark ceases to be provided; (ii) a benchmark or its administrator is
not approved; (iii) a benchmark or its administrator is not included in an
official register; or (iv) the approval or inclusion of a benchmark or its
administrator in the official register is suspended or withdrawn. If one of
these events occurs, the ISDA Benchmarks Supplement provides for a right to
terminate all transactions under the relevant ISDA documentation if a
fallback cannot be agreed/implemented. If the parties fail to agree on an
appropriate fallback, if documented under a 2002 Master Agreement, it would
trigger a “Force Majeure Event” with any outstanding swap transaction being
the sole “Affected Transactions” and with both parties being the “Affected
Parties”. If the Master Agreement is not a 2002 Master Agreement, it would
be treated as an “Additional Termination Event” with the same effect.
Implementation and Effect on New and Legacy Documentation
The use of the ISDA Benchmarks Supplement is voluntary and may be agreed
bilaterally between parties — either in each confirmation or on a
relationship level. Before agreeing to the use of the ISDA Benchmarks
Supplement, parties should consider whether it is appropriate for the
specific transaction. Note that provisions that incorporate the ISDA
Benchmarks Supplement, but also provide parties with an additional
termination right (such as (i) if the fallback benchmark determined in
accordance with the ISDA Benchmarks Supplement would not provide a suitable
hedge for a party, or (ii) a party may lose the benefit of hedge accounting
in respect of any transactions referencing the fallback benchmark) are
being included in new ISDA documentation by market participants.
ISDA has subsequently published an ISDA 2018 Benchmarks Supplement Protocol
to which parties can adhere. The Benchmarks Supplement Protocol allows
parties to incorporate the Benchmarks Supplement into their ISDA Master
Agreements quickly and efficiently. Parties that adhere to the Benchmarks
Supplement Protocol can elect to incorporate the Benchmarks Supplement into
all existing and new transactions or into only new transactions. However,
for the Benchmarks Supplement to be incorporated into transactions between
two adhering parties, the parties must also exchange their completed ISDA
Benchmarks Supplement Protocol Questionnaires.
The Year Ahead
Although the ISDA Benchmarks Supplement was published over five months ago,
market participants have been slow in incorporating that supplement into
their ISDA documentation. To date, only 25 market participants have adhered
to the Benchmarks Supplement Protocol.
In addition to adherence, in finance linked swap transactions, parties have
now started to incorporate the ISDA Benchmarks Supplement specific
termination rights into intercreditor agreements and ISDA Schedules. Legacy
intercreditor provisions will need to be reviewed to determine if there is
an existing termination right that can be exercised in the absence of an
express termination right in this regard.
Market participants should also consider the effects of the ISDA Benchmarks
Supplement in light of the recent attention surrounding the potential
cessation of LIBOR and other IBORs and ISDA’s work to implement fallbacks
to these benchmarks. Such fallbacks could trump the ISDA Benchmarks
Supplement fallbacks with regard to LIBOR or IBOR transactions to which
both work streams apply. Until ISDA has completed its work on LIBOR and
IBOR, the ISDA Benchmarks Supplement will determine the primary fallbacks
that apply to LIBOR and IBOR. ISDA is expected to complete its work to
implement fallbacks to LIBOR and IBOR in mid-to-late 2019.
For further information, please contact the McGuireWoods London debt