LCH’s position in respect of ISDA’s recommended Benchmark Fallback Approaches
LCH Circular No 3999
20th December 2018
All LCH Ltd SwapClear Users
LCH Group (“LCH”) and its SwapClear business strongly supports the ongoing industry-wide moves to reform many of the benchmarks which, when used in derivatives contracts, currently rely on definitions and processes that are not sufficiently robust (each a “Current Definition”).
One focus of this reform work is on benchmark fallbacks. LCH commends ISDA for the lead it has taken in consulting with OTC derivatives market participants in this respect. We note that the current ISDA consultation relates to a specific set of benchmarks, that its preliminary results have been announced, and that ISDA will launch supplemental consultations relating to additional benchmarks in due course. For each such consultation, we note that:
- The consultation sets out potential approaches for calculating adjustments that would apply to the fallback rate in the event that a benchmark is permanently discontinued, such fallback rates being the risk-free rates (RFRs) identified and recommended as alternatives for each relevant benchmark;
- The responses to the consultation in respect of each benchmark will determine the approach selected (each a “New Fallback Method”), the detailed specifications of which will be determined by the process already outlined by ISDA and which may involve additional market feedback;
- Each New Fallback Method, once determined, will be made available to be incorporated into both new and legacy contracts via a number of mechanisms, including via a supplement or amendment to the “Rate Options” for the relevant benchmarks in the 2006 ISDA Definitions (in each case a “New Definition”); and
- Each New Definition will replace the corresponding Current Definition in the 2006 ISDA Definitions as those definitions apply to contracts entered on or after the New Definition is published.
The central objective of this work is to make sure that derivative contracts have the robust fallbacks that are necessary to ensure continued financial stability. In support of this objective, we believe central counterparties should provide their users with confidence and, where possible, certainty over the relationship between the outcome of these ISDA consultations, and the treatment of contracts that they clear and which rely on these benchmarks.
LCH understands that we will need to support the market in a number of ways. First, contracts incorporating a New Definition will need to be eligible for clearing by SwapClear. Second, we will need to determine the relationship between contracts incorporating a New Definition, once eligible, and the population of open contracts incorporating a Current Definition. Third, we will need to determine whether we continue to accept for clearing newly transacted contracts based on the covered benchmarks that do not incorporate a New Definition.
With this in mind, we announce the following intentions:
- We will aim to provide clearing eligibility for new contracts incorporating a New Definition from the date on which the New Definition in respect of that benchmark is published by ISDA (each a “New Definition Eligibility Date”), provided that ISDA has pre-published a finalised supplement giving sufficient advance notice of such publication;
- Prior to each New Definition Eligibility Date, only contracts incorporating a Current Definition will be eligible for clearing;
- From and including each New Definition Eligibility Date, only contracts incorporating a New Definition will be eligible for clearing;
- On each New Definition Eligibility Date, all outstanding contracts incorporating a Current Definition will be amended so as to incorporate the corresponding New Definition;
- We will introduce rulebook amendments to give effect to this, where necessary, through our regular Rulebook change consultation process (an assessment of such changes is currently underway). Our changes may also extend to provide additional clarification beyond those given in a New Definition, for example with respect to the events that could trigger a move to an alternative rate.
In outlining these intentions, we make the following observations:
- Today, for contracts incorporating a Current Definition of a benchmark which ceases to be available, LCH is permitted, at its sole discretion, to determine an alternative rate
- We believe it to be in the interests of the derivatives market as a whole that the New Definitions, on which ISDA has consulted comprehensively, are adopted quickly by the market, whether through the use of the New Definitions directly in new contracts or through application of the New Definitions to outstanding contracts via the legal mechanisms being made available, and that LCH aims to support their adoption through the approach outlined in this notice;
- Conversely, we believe it to be in the interests of the derivatives market that the number of contracts reliant on Current Definitions is minimised once a New Definition is available;
- LCH reserves the right to make a final judgement as to the viability of a New Definition once the corresponding New Fallback Method is fully specified, whether on operational, technological, legal or risk management grounds;
- In the event that LCH determines that each such New Definition is viable, it will confirm this via a circular. This will be published on or around the date on which ISDA pre-publishes its finalised supplement and will include a corresponding New Definition Eligibility Date, upon which LCH is committed to implement the intention outlined above;
- Implementation of New Definitions is subject to LCH’s usual review and governance process, including in respect of regulatory compliance.
 For example, FSB, July 2014 onwards ( http://www.fsb.org/what-we-do/policy-development/additional-policy-area… ); Andrew Bailey, FCA, July 2017 (https://www.fca.org.uk/news/speeches/the-future-of-libor )
 Primarily reflected in the 2006 ISDA Definitions
 As defined in Section 1.8.12 of Section 2C of the SwapClear Procedures ( https://www.lch.com/system/files/media_root/Procedures%202C%20-%2005%20… )