Fallback procedure documents

Four documents related to the IBOR fallback have been published a couple of days ago:
- Anonymized Narrative Summary of Responses to the ISDA Consultation on Term Fixings and Spread Adjustment Methodologies prepared for ISDA by The Brattle Group
- LCH’s position in respect of ISDA’s recommended Benchmark Fallback Approaches
- CME Group Supports ISDA’s LIBOR Fallback Provisions
- Second public consultation by the working group on euro risk-free rates on determining an ESTER-based term structure methodology as a fallback in EURIBOR-linked contracts

Those documents are welcome as they clarify the results of the ISDA consultation and the CCP positions.

I will start with the CCP side. To my knowledge, this is the first time CCPs provide an explicit document related to the fallback. Up to now there were only informal "ISDA is liaising with the CCPs". The content of CCP notes can be summarized as CCPs will adopt the new rules, but reserve the right not to do it and if a CCP changes the rules, they will apply to new and legacy trades. So we can already guarantee a fork in the swap definitions between cleared and uncleared. If the new ISDA rules are not adopted in a CCP rule book, there is an obvious fork for the new trades; if the new ISDA rules are adopted by a CCP, they apply to legacy trades also and there is a fork for the legacy trades.

The ECB working group consultation indicates that some market participants are not happy with the "compounded setting in arrears" and would prefer a derivative based term RFR for the (EURIBOR) fallback. This was the "Option S1" in my answer to ISDA. Another consultation to answer to.

On the ISDA consultation side, I have already express my disappointment at the publication of the preliminary results on the choice of the "compounding setting in arrears" option which is, in my opinion, not achievable. That disappointment was accentuated when I saw that 90% of the respondents are in favour of it. But the same disappointment receded when I reached page 65 / paragraph 178 of the report. That is  the "comments on the implementation" section. That is where the actual details on what the respondents actually mean when they selected "compounding setting in arrears" is hidden. Reading it, I can see what I mentioned: it cannot work as described in the consultation document and some contract term sheet will need to change (FRA in particular) (see the blog where I mentioned changes to term sheets).

The comments include (unfortunately the authors are not indicated in the ISDA document and I cannot credit the authors properly)

1. "unable to transact certain instruments under the compounded setting in arrears"
2. "Certain instruments such as FRAs (which pay in advance) would not be able to make use of a fallback where the relevant information was not available until the end of the IBOR period"
3. "incompatible with the contractual requirements of Forward Rate Agreements (FRAs)"  and "potential mitigating arrangements to cater for these" from a CCP
4. "As the recent issuance of SOFR-based and SONIA-based FRNs has indicated, determining coupon cash flows on the cash flow date is not practicable." (something I highlighted in my blog on those products)
5. "situation arises in which the overnight fixing will most likely not be known on the payment date for the IBOR, so the actual value of the IBOR cannot be computed."
6. "some modification (lock up or backward shift)"
7. "payment delay" which "must be achieved in a manner that applies consistently to both the IBOR and any derivative that it references."
8. "have difficulty adopting an alternative RFR without a payment date delay adjustment or a lockout period."
9. "a compounded [setting] in arrears rate either a short fixing lag or lock-out period."

It seems we need a new consultation to clarify what was the meaning of the option "compounding setting in arrears" in the first consultation. I cannot parody a famous sentence and say "compounding in arrears means compounding in arrears".

The preliminary results ISDA statement indicates that "as part of that decision, the ISDA Board Benchmark Committee will set out the details related to the adjusted RFR and spread adjustment that remain outstanding". The summary of responses referenced above does not help on the details front. As the name indicates, this is a summary of the responses, not a first step in the direction of a clear and detailed proposal. It is based on the number of responses in favor of each option, not an analysis of the quality of each of them.

The search for a manageable fallback procedure continues!