Fallbacks Protocol Effective

The IBOR Fallbacks Protocol is legally effective as of today. Following a permanent IBOR cessation, or an FCA determination that a LIBOR has “become” non-representative, fallbacks in the form of adjusted risk-free rates will apply to in-scope derivatives contracts. Clearly, the Protocol only applies to those who have adhered- 11902 to date. Purely in terms of adherence, this number marks the Protocol as a qualified success. By contrast, the March 2013 DF Protocol has 25614 adherents, while the ill-fated 2016 VM Protocol has 1251. The Protocol remains open for adherence by all, but the $500 fee will now apply, regardless of ISDA member status.

The Protocol/Supplement mechanism is intended to act as an insurance policy, mitigating the systemic disruption consequent on a combination of rate cessation and a widespread failure to conclude bilateral amendments. Inevitably, given the scale of the LIBOR repapering challenge, the Protocol may be seen as a strategic rate-transition tool, rather than a safety net for bilateral negotiations that exceed cessation. To this end, the Protocol is an effective and elegant solution, albeit with the following caveats:

• With the notable exception of the DRV, the Covered Documents list under the Protocol is extensive, comprising inter alia: GMSLA, GMRA, FBF, MSLA and CMOF documents. Understandably, ISDA have only commissioned legal opinions in respect of their own documentation. Adherents using the Protocol to amend non-ISDA documents effectively do so at their own risk.
• The Protocol only covers derivatives Master Agreements, it has no application for other LIBOR-referencing asset classes such as loans or bonds, the documentation of which is typically less homogenised and present their own specific challenges such as corralling agreement across large syndicates.
• Even within its covered documents, the Protocol is designed to amend documentation in respect of vanilla, “stand-alone” transactions. Bilateral amendment will be required for the following broad areas:

1. Packaged or structured transactions where the derivative is precisely hedging another product
2. Non-linear” derivatives such as:  swaptions, caps, floors, collars etc.
3. Exotic products which reference a “floating rate” outside of the ISDA Definitions e.g. commodity swaps, earthquake, weather swaps etc.

Despite fairly widespread adherence, bilateral amendment is required for non-adherents and remains the preference between adherents; the process is already well underway. Interestingly, a number of first drafts prefer a document-specific approach, resulting in multiple amendments rather than simply listing covered documents in one. Conferring neither legal clarity or operational simplicity, it’s unclear why participants would elect for multiple amendments. Benchmark reform is unique in the breadth of its scope across both document type and participant population; while BRRD comprised a broad range of documents, it only applies to a relatively small subset of participants. It may be that participants are simply used to document-specific amendments e.g. one for a CSA, one for a GMSLA etc. The more cynical may see this approach as prompted by the natural desire for law firms to maximise fees.

Irrespective of amendment process minutiae, the Protocol’s “activation” represents the first stage in tackling the benchmark behemoth- an effective safety net is now in place for the systemically-significant portion of the derivatives market. However, the scale of the challenge remains vast- bilateral amendment remains the only option in respect of non-adhering derivatives counterparties and of transactions for which the Protocol is ill-suited.

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