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Chatham’s responses to ISDA’s LIBOR consultations

Date:
September 19, 2019

Summary

Chatham believes that pre-cessation fallback provisions should be included in the Supplement to the 2006 ISDA Definitions and the related Protocol.

In May 2019, the International Swaps and Derivatives Association (ISDA) released two consultations for public comment. One of the consultations focused on spread and term adjustments for fallbacks in derivatives referencing USD LIBOR, CDOR, HIBOR, and SOR (the 2019 Supplemental Consultation), while the other consultation focused on issues related to the potential inclusion in derivatives documentation of language that would trigger the transition to a fallback rate before an IBOR has actually ceased being published (this is known as a “pre-cessation trigger,” and we refer to this consultation as the “2019 Pre-Cessation Consultation”). Chatham responded to both ISDA consultations in July 2019, and our responses were focused on the potential impacts of ISDA’s proposals on derivatives end users.

We emphasized that maintaining flexibility is crucial for end users at this stage.

Fallback and spread in the supplemental consultation

In our response to the 2019 Supplemental Consultation, Chatham advocated for a compound setting in arrears rate for the fallback and a forward approach for the spread adjustment. In a prior 2018 ISDA consultation on IBOR fallbacks, Chatham had previously preferred the historical mean/median approach for the spread, but because Chatham has observed that U.S. market conditions have changed since the release of the 2018 ISDA consultation results, we now prefer the forward spread approach since it allows the spread to evolve based on market forces rather than remain static based on historic spread calculations. ISDA has released preliminary results of the 2019 Supplemental Consultation, and while most respondents agreed with Chatham’s preference for compounded setting in arrears for the fallback rate, the majority of respondents disagreed with Chatham on the spread and preferred the historical mean/median approach over the forward approach. Although the number of respondents to this consultation was somewhat low, it is likely that ISDA will use the compounded setting in arrears rate and the historical mean/median approach for the spread when it amends its 2006 ISDA Definitions for use in derivatives documentation.

Determining the end of LIBOR in the pre-cessation consultation

In Chatham’s response to the 2019 Pre-cessation Consultation, we emphasized that maintaining flexibility is crucial for end users at this stage, and we did not universally recommend including pre-cessation triggers in derivatives documentation at this time since there are still so many uncertainties around IBOR fallbacks. ISDA’s preliminary results for this consultation noted that respondents generally fell into the following three categories, with no clear majority in any one category: 1) those who supported the inclusion of a pre-cessation trigger in ISDA’s Definitions, 2) those who only supported the inclusion of a pre-cessation trigger if it is implemented with optionality and flexibility, and 3) those who opposed the inclusion of a pre-cessation trigger.

ISDA issued a new consultation on the final parameters for the spread and term adjustments for their fallback language. Chatham will submit our response to this consultation in late October 2019. You can find Chatham’s complete responses to previous ISDA consultations here: 2019 Supplemental, 2019 Pre-cessation, 2018 Aspects of Fallbacks for Derivatives.


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Disclaimers

Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.

Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.

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