Update on LIBOR Reforms and ISDA Documentation

February 27, 2019

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or (iv) the approval or inclusion of a benchmark or its administrator in the official register is suspended or withdrawn.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 finance team.