Marketing barrage on signing ISDA Fallback Protocol in escrow

Recently ISDA, ARRC and regulators have started a joined marketing barrage to convince market participants to adhere to the ISDA Fallback Protocol “in escrow”.

I have commented on the Protocol signature many times before in seminars and on LinkedIn but not directly in a post. I have tried to summarize some of my arguments below.

Before doing that, I have to repeat that I agree that a robust fallback is required. The current ISDA definitions do not contain a robust fallback and something needs to be done.

Where we disagree is that the ISDA proposed fallback is the only one that is possible. I even disagree that the ISDA proposed fallback is actually robust, but that is another story that I have already discussed in many other posts (for example Fallback compounding in arrears won't work).

Even if someone today believes that the protocol is the best alternative for him, there is no advantage in early adherence. The adherence is like a pure American option, i.e. whenever you exercise it you lose you exercise right and you always receive the same underlying at the same date (on the discontinuation date). In some cases, American options should be exercise early when there is some dividend or cost of carry associated. This is not the case here, you always receive the same thing at the same date. On the other side, there is no way back; once you have signed, you cannot remove your signature. To be fair, there is one advantage in signing early, it is to avoid "serious questions" by regulators. But if someone signs blindly, he should have "serious questions" from his investors.

It seems that all the ISDA, ARRC and regulators recent communication is based on a logical fallacy. Because something need to be done does not mean that the "something" has to be the proposed by ISDA/ARRC solution.

I have explained in a Risk.Net published opinion why the signature of the protocol based on the ISDA fallback proposal is creating a value transfer. The underlying research has been made available openly and presented in many public and private seminar. I have received many positive comments and consulting requests related to the underlying results; I have not received a single disagreement comment. ISDA has always agreed that the change of fallback will create "winners and losers".

Why would an end user sign the global protocol without assessing first if he is in the winners or losers camp? Do your analysis, you should still have a year or so to do it. Check the impact for each counterparty. If the counterparties against who you are a winner in case of ISDA fallback have already sign, this is good for you; they have lost their option, you still have yours. You can contact them to sign a standard bilateral agreement with the same intent as the protocol without compensation. On the other side, contact the counterparties against whom you are a "loser" in case of signature and tell them that you would like a tailor made agreement with a compensation for the unfairness of the standard agreement. Remember, FCA insisted that "clients are treated fairly and their interests are upheld throughout" (see "Serious questions" about FCA warning!). This means that your request for a fair fallback agreement cannot be refused.

To me this barrage of communication sound like a proof of weakness. They sense that there is no real momentum for the signature and hope that in repeating "you should sign" enough, part of the participants will sign. As there is no way back from signature, each "one minute weakness" of a participant is a final victory; a victory in any battle is a victory of the war.

In the ARRC text, I took a couple of sentences where the fallacy of the arguments is visible:

Protocol is critical to ensuring that existing derivatives contracts feature durable fallbacks.
This is clearly incorrect. Protocol is one way to achieve a fallback. There are many other ways, including bilateral negotiated agreements. It is not the Protocol which is critical, it is to have a robust fallback.

should adhere [...] before the amendments to embed the fallbacks in legacy transactions take effect.
The fallback is useful and meaningful only when LIBOR is discontinued, there is no objective reason to sign before that date. There is not a single argument to adhere early or before an arbitrary date.

The IBOR Fallback Protocol is crucial [...].
A fallback (with an indefinite article) is crucial, not THE fallback (with a definite article) from ISDA as described in the Protocol. Any robust fallback will do.

Similar fallacies where presented by FCA representatives in several webinars. Start by explaining why "A" fallback is required and conclude that you should sign "THE" fallback presented or face "serious questions". The way those "serious questions" are presented, they somehow feel like blackmailing to me. 

 

Note added 2020-08-25: My comment from a LinkedIn post related to a discussion around a FCA speech LIBOR transition – the critical tasks ahead of us in the second half of 2020.

This is exactly the type of reasoning I had in mind when I mentioned "logical fallacy". It explains that "A => B" (signing the protocol => meets the requirement) with reference to a regulation. Then the next sentence is "no A => no B" (not to sign => serious question), almost as it was the same and also regulatory mandated. Or they don't understand basic logic or they are of bad faith.

I would concede that firms not signing will need to be ready for some "serious questions" if they concede that firms signing should also be ready for some "serious questions" (different questions obviously, but nevertheless serious questions) and that anybody advising signing without an in depth analysis of the portfolio of the user he advises (counterparty exposure, hedging of other instruments, valuation, risks) should face serious questions, on conduct risk in particular.