FSB letter to ISDA regarding derivative contract robustness

The Financial Stability Board (FSB) has send a letter to ISDA about "derivative contract robustness to risks of interest rate benchmark discontinuation. The letter is public and available on the website of the FSB: http://www.fsb.org/2019/03/fsb-letter-to-isda-about-derivative-contract-robustness-to-risks-of-interest-rate-benchmark-discontinuation/

I would like to point to a couple of extracts of the letter than corroborate elements than I have mentioned in previous post. Those elements concern the process that lead to the changes in the fallback definition, and in particular those who have a value transfer impact.

In this regard, we encourage ISDA to consult [...] on the key technical details that ISDA’s Board Benchmark Committee will need to decide on before implementation can begin (including the parametrisation of the historical mean/median look-back, and the details of how the credit spread will be calculated and applied over the compounded rate).

The importance of this work is such that a careful process of assessment and consideration is essential before the publication of outcomes. [...] It is equally important to ensure transparency around how ISDA’s Board and/or Benchmark Committee would arrive at its decision.

The consultations from ISDA (and other working groups pursuing similar objective regarding benchmark transition) asked several questions with large range of possible answers. Certainly all the market participants answering those questions have their preferred solution in mind. On the other side, the groups in charge in reviewing the answers have only the answers at disposal, not the mind of the participants. It is essential for transparency that the exact way that the answer will be interpreted are described at the same time as the consultation. Some of the natural questions that need to be answered are:

• Are the consultation results binding for ISDA? 
• What if one of the option proposed is not achievable? This appear to be the case. What is done with the results? Should a full consultation be done again? 
• When a question has a range of answers, how are the answers ranked? For example the spread computation "historical mean/median" has choice between mean and median, choice of the length of the historical period and choice on the transition period. Are all those choice votes for the same option or each alternative a separate option.
• How are the results interpreted? The approach that has the most votes? Should an ordered of preference be ask for all non yes/no questions? Is there a weight by the importance of the participants? How would their importance be measured, with their weight in the derivative market, the size of their balance sheet, their quantitative finance expertise?

The Board also indicates the importance of transparency. In particular I believe it is important to indicate in advance how is the decisions will be communicated to the market. ISDA's Board and Benchmark Committee members are also in large part staff members in financial institutions trading IBOR derivatives. How is the potential conflict of interest between ISDA decisions and their impacts on institutions remunerating those members managed?

As described in different posts, the decisions can have a significant impact on the market and transferring value between market participants. Those transfers have already started and will continue which each decision. Certainly all those senior officers are looking in details at the impact of the LIBOR fallback and transition in their respective institutions. This is their duty and they certainly perform it diligently. This means that when they meet at ISDA for the decisions related to benchmarks, they know the impact of those decisions have on their institution's P/L and potentially on their own salary/bonus. How is that inherent conflict of interest managed? I guess that was the question behind the "important to ensure transparency around how ISDA[...] would arrive at its decision" sentence in the FSB's letter. When the decision has been taken but is not yet public knowledge, they board and committee members have an insider information. Beyond the decision making process transparency requested by FSB, it would be of interest also to request the transparency on the decision making timing. As suggested in a previous note, I recommend to have the decision made on a Saturday (outside market open hours) and publicly announced immediately (press release and detailed document publish on the website). In that way the interested market participants can be prepared at the opening of the markets on the next Monday.