ISDA pre-cessation fallback consensus: will this reduce legacy LIBOR risk in the derivatives market?

The International Swaps and Derivatives Association (ISDA) has announced the preliminary results of its re-consultation on the implementation of pre-cessation fallbacks for derivatives referenced to LIBOR (see press release). It follows an earlier consultation on pre-cessation fallbacks last year, which failed to achieve market consensus on whether or not (and if so, how) to include a pre-cessation trigger (see the consultation and the results), causing a delay to the development of a way forward in the critical derivatives market. See our previous blog post on ISDA’s decision to carry out a second consultation.

While these are only preliminary results, ISDA expects to proceed on the basis of the views of the significant majority of respondents who are in favour of including both pre-cessation and permanent cessation fallbacks as standard language in the amended 2006 ISDA Definitions for LIBOR and in a single protocol for including the updated definitions in legacy trades.

It is noteworthy that ISDA has published the fact that consensus has been reached at the earliest opportunity (without the usual practice of including a preliminary report), recognising the significance of the outcome of this consultation for the market.

The outcome is significant because it will allow ISDA to press ahead with finalising the way forward in the critical derivatives market and give impetus to other markets to progress their own solutions.  Moreover, this should avoid different derivative contracts switching away from LIBOR at different times (which would have created mismatches between different parts of a portfolio). However, some market participants will be concerned at the loss of flexibility in how to address LIBOR cessation across their derivative positions, which may have the undesirable effect of putting them off adhering to the protocol at all.