LCH’s proposed position in respect of Benchmark Fallbacks and Forward Rate Agreements (FRAs)
LCH Circular No 4127
8th December 2020
All SwapClear Users
This notice is to update SwapClear users on LCH’s proposed position in respect of the ISDA IBOR Fallbacks Supplement and their application to Forward Rate Agreements (FRAs).
The IBOR Fallbacks Supplement
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”).
ISDA has taken the lead in respect of enhancing benchmark fallbacks in derivatives, and we were pleased to note the progress outlined in the recent ISDA Board Statement. In this notice, ISDA announced the launch on October 23, 2020 of (i) the ISDA 2020 IBOR Fallbacks Protocol (the “Protocol”) and (ii) the IBOR Fallbacks Supplement to the 2006 ISDA Definitions (the Supplement), and that both will take effect on January 25, 2021. For each benchmark within the scope of the Supplement, new fallback arrangements will be made available and will be incorporated automatically into new contracts via a supplement to the “Rate Option” for the relevant benchmark in the 2006 ISDA Definitions (in each case a “New Definition”).
LCH has previously expressed its intention to adopt these supplemented definitions. We did so in order to provide our users with as much clarity and certainty as possible over the treatment of contracts that we clear and which rely on these benchmarks. At that time, we announced the following intentions:
- We would provide clearing eligibility for new contracts incorporating a New Definition from the date on which the New Definition in respect of that benchmark was published by ISDA (each a “New Definition Eligibility Date”), provided that ISDA had 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 would be eligible for clearing;
- From and including each New Definition Eligibility Date, only contracts incorporating a New Definition would be eligible for clearing;
- On each New Definition Eligibility Date, all outstanding SwapClear contracts incorporating a Current Definition would be amended so as to incorporate the corresponding New Definition;
- We would introduce rulebook amendments to give effect to this, where necessary, through our regular Rulebook change consultation process. We also expressed that our changes might extend to provide additional clarification beyond that given in a New Definition, for example with respect to the events that could trigger a move to an alternative rate.
When outlining these intentions, we made a number of observations, including that we reserved the right to make a final judgement as to the viability of a New Definition once it had been finalised, and that: (i) we would confirm this via a circular to be published on or around the date on which ISDA pre-published its finalised supplement; and (ii) we would include a corresponding New Definition Eligibility Date.
We are pleased to confirm that the New Definition Eligibility Date will be 25th January 2021 in respect of any and all contracts linked to the following benchmarks, regardless of their Designated Maturity: AUD BBSW, CAD CDOR, CHF LIBOR, EUR EURIBOR, EUR LIBOR, GBP LIBOR, HKD HIBOR, JPY LIBOR, SGD SOR, THB THBFIX and USD LIBOR (together, the “In-scope Benchmarks”).
The arrangements detailed above will apply in respect of these benchmarks.
Intended approach for Forward Rate Agreements (FRAs)
The ISDA IBOR Fallbacks are a one-size-fits-all safety belt, designed to provide contractual certainty to the widest number of transaction types documented under the 2006 ISDA Definitions. Regulators, like the UK Financial Conduct Authority, have repeatedly stated that market participants should consider pro-actively transitioning their LIBOR referencing derivatives ahead of fallbacks becoming effective in order to secure the best outcome. ISDA has published a matrix setting out the impact of the fallbacks on different transaction types. Although this makes clear that the fallbacks would provide an outcome for FRAs, we believe the backward-looking nature of the prescribed ISDA fallback methodology, given the time lags involved, means there is likely to be a significant impact on FRAs, which ordinarily rely for their fulfilment on a forward-looking rate input at expiry. With this in mind, we encourage SwapClear users to consider ceasing their activity in FRAs with an expiry date beyond the end of 2021, and for example switching to the use of corresponding single period swaps for which this issue does not arise; we are grateful to other third party providers from whom we receive trades for adapting their risk management services away from generating FRAs as an output. Nonetheless, we are mindful of the clearing obligation that applies to certain market participants in respect of their execution of some FRAs, and the need to be ready to manage such products. In keeping with our prior commitment to provide clarity and certainty to our users, we are therefore writing to announce the following intention:
For any open FRA contract registered with SwapClear which relies for its contractual fulfilment on an In-scope Benchmark for which (a) the Index Cessation Event has occurred and (b) the Index Cessation Effective Date is the date or precedes the date on which the contract’s fixing will occur, LCH will upon the announcement of such Index Cessation Event make arrangements to convert, on the Index Cessation Effective Date, the FRA into a single period swap with an Effective Date equal to the settlement date of the original FRA contract and running for a period equal to its Designated Maturity, and a Fixed Rate equal to the Fixed Rate on the original FRA contract.
LCH intends to introduce rulebook amendments to give effect to this, where necessary, through our regular Rulebook change consultation process.
Furthermore, LCH plans to apply a FRA conversion facilitation fee for any contracts within the scope of this proposal. Further details of this will be communicated in due course.
LCH also intends to consult further on plans to transition the portfolio of LIBOR contracts (including FRAs) to RFRs.
 Primarily reflected in the 2006 ISDA Definitions
 Capitalised terms not otherwise defined here have the meaning given in the 2006 ISDA Definitions as supplemented from time to time