On October 23, 2020, the International Swaps and Derivatives Association (“ISDA”) released the ISDA IBOR Fallbacks Protocol (“Protocol”) and a Supplement to the 2006 ISDA Definitions (“Supplement”). While the Supplement amends definitions to the 2006 ISDA Definitions, it only amends definitions for new contracts. The Protocol gives participants an opportunity to amend existing contracts.
Fallback Cessation Event
Once USD LIBOR publication discontinues at the end of 2021, many contracts referencing USD LIBOR will fall back to the Secured Overnight Financing Rate (“SOFR”), as we have discussed in previous blog posts. For more information, please see our introductory post on SOFR.
With respect to Protocol-covered documents (i.e., ISDA Master Agreements and ISDA Credit Support Documents, etc.), USD LIBOR’s fallback to SOFR, both the Protocol and Supplement, rely on an Index Cessation Event, which is, in sum, a public statement by the provider of the Applicable Fallback Rate (LIBOR) announcing that it has ceased or will cease to provide the Applicable Fallback Rate permanently or the rate is no longer representative.
The Protocol acts as a way to amend an existing contract that references IBOR. In order to amend an existing contract with the Protocol, a party must agree to adhere to the Protocol, by which they agree to amend all of its contracts with any other adhering parties. Most importantly, if a party adheres to the Protocol, it amends its existing contracts in line with the Supplement. If a party chooses to adhere, they can execute an Adherence Letter (the Protocol supplies a Form of Adherence Letter). ISDA will publish a list of adhering parties on its website.
The Supplement amends the 2006 ISDA Definitions, and generally amends existing definitions with a fallback from IBOR to alternative reference rates, including SOFR for USD LIBOR. The Supplement sets forth that once there is an Index Cessation Date, the SOFR fallback rate will be determined according to the Adjusted SOFR Rate and the Spread Adjustment. The Adjusted SOFR Rate will be compounded in arrears. The Spread Adjustment will be the median of the historical difference between USD LIBOR and the compounded SOFR rate, with a 5-year lookback period. The Spread Adjustment added to the SOFR rate is a mechanism designed to compensate for the differing natures of using a backward-looking risk-free rate (SOFR) instead of a forward-looking rate (LIBOR).
Beginning on the Index Cessation Date, the SOFR Fallback Rates and the Spread Adjustment will be published by Bloomberg Index Services Limited.
The Protocol and Supplement will be effective on January 25, 2021, depending on when parties adhere to the Protocol with respect to previous contracts. Instead of each party to existing swaps constructing individual solutions for the transitions, the Protocol and Supplement provide a uniform transition from LIBOR to SOFR. These publications were included in many timelines for market participants, including the Alternative Reference Rates Committee’s 2020 Best Practices (as discussed in a previous blog post) and mark a significant and long-awaited step forward to a seamless transition away from LIBOR.
Norton Rose Fulbright has assembled a group of its attorneys from around the globe to stay on top of these issues and assist clients in the transition to new reference rates. More information can be found here.