Fact-check on ISDA fallback fact sheet (2)

ISDA has published a second "Fact Sheet" on IBOR fallbacks. Following a post on the previous version, I'm adding one post on this version.

Calculations to be published [by Bloomberg] are: Adjusted RFR, Spread Adjustment, Fallback Rate
.

No problem with that. Bloomberg is allowed to publish those calculations as I have been allowed to do the same for more than two years.

A License is required from Bloomberg for the re-distribution or usage of the Adjusted RFRs, the Spread Adjustments and the Fallback Rates.

I'm not sure what that means exactly. Does that means that a license from Bloomberg is required for re-distribution or usage of Bloomberg data or that a license is required to re-distribution or usage of any data? In the first case, I would not disagree, if someone wants to pay Bloomberg, he is free to do so. In the second case, I have a strong disagreement. You cannot hold a license or copyright on facts or ideas. The RFR data, mostly published by central banks, are facts and public information, the ideas and formulas behind the composition are more than 500 years old and in any case cannot be copyrighted or patented and the computation of a median of the said data is also unprotected.

One financial institution that requires those data sets has many choices. Among those choices, one is to pay Bloomberg a recurring fee between 20,000 and 100,000 USD a year, just for the data. One other choice is to hire me for a 2 days course on LIBOR transition and then hire me for a week of consulting to implement with its developers in its own system the computation of those numbers. I can already tell you that the bill will be below 20,000 USD and a one-off/non-recurring item. Contact me for details. There are also many other choices, but don't expect me to advertise for the competition.

The adjustment calculations described in this fact sheet aim to facilitate this transition and the adoption of these RFRs but the IBOR Fallbacks are not themselves separate benchmarks for purposes of the EU benchmark regulation (including similar applicable frameworks, ‘BMR’).

I have read this claim by ISDA and others, but I have not seen any arguments backing this claim. I have asked the question since last year (see EU BMR and rate transition post), including to ISDA, but I have not received an answer about it.

The BMR relevant articles are, to my understanding,

Article 3, 1 (3): ‘benchmark’ means any index by reference to which the amount payable under a financial instrument or a financial contract, or the value of a financial instrument, is determined
Article 3, 1 (7): ‘use of a benchmark’ means: (b) determination of the amount payable under a financial instrument or a financial contract by referencing an index or a combination of indices;

Clearly, after the fallback, the amount payable is determined by the RFR rate and the adjustment spread. The adjustment spread is not fixed today and is based on indices (SOFR and LIBOR for USD, ESTR and LIBOR/EURIBOR for EUR). There is clearly a "use of benchmark". There is maybe a possible discussion about the adjective "separate". The fallback is based in SOFR and LIBOR and is not an additional benchmark type but is a different and separate number from a SOFR only number. We have to make sure that all the elements are compliant. I have no doubts about the direct SOFR/ESTR part, but I have doubts about the SOFR/ESTR part used in the spread. The SOFR/ESTR data is actually not only real SOFR/ESTR data, but also pre-SOFR/pre-ESTR data. For SOFR, it is explicitly mentioned by the Fed that they are "proxies" for SOFR and not SOFR itself. The actual wording from the Fed  are "can act as a reasonable proxy" and "modeled, pre-production estimates of SOFR". My questions are: is pre-SOFR "separate" from SOFR and is pre-SOFR compliant with EU BMR?

For EUR, the situation is clearer, the ECB explicitly indicated

The pre-ESTR is only a set of indicators for the ESTR. Its publication is for information purposes only and the data are not intended for use as a benchmark in any market transaction, whether directly or indirectly.

In this case, as discussed in a January blog, the ISDA proposed spread adjustment cannot be used in derivatives under EU BMR. The adjustment spread is clearly an indirect use. And I don't even mention the potential use of EONIA for older data.

Fallback Observation Date <- 2 business days - Payment Date (in Figure 1).

As discussed in several blogs, e.g. Fallback and same day payment?, and several notes, the end of observation date and payment date have complex relations. Even if we take the plain vanilla swaps with payment frequency in line with underlying LIBOR, the "2 business day" difference is incorrect in many case. The latest description of the compounding period (I say latest, because it has changed many times over the last years) is a starting date of the compounding 2 days before the effective date of the LIBOR and a end date computed from the start date and LIBOR tenor. Because of non-good business days, the end compounding/observation date will in many cases NOT be 2 days before the payment date, it can be the same date.

If you take not so vanilla instruments, like a IMM swap or swap with combined calendars for payment dates, the end of compounding can be after payment, up to one week after. The so-called "fallback rule book" does not have a rule about this issue. Each user will be required to negotiate bilaterally a rule with each of its counterparties individually. This is on top of many products that are not covered at all by the ISDA/Bloomberg rules: FRA, LIBOR in arrears, range accrual.