ISDA to re-consult on pre-cessation fallbacks: litigation risk for legacy LIBOR contracts

This article was originally published on Banking Litigation Notes.

The International Swaps and Derivatives Association (“ISDA”) announced yesterday that it will re-consult on how to implement pre-cessation fallbacks in derivatives contracts. This is an important development for financial institutions with large books of legacy LIBOR-linked products.

The announcement 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). It also follows quickly on the back of new information released by the FCA and ICE Benchmark Administration on the length of time LIBOR may be published following a regulatory statement that the benchmark is no longer representative of the underlying market. The FCA has confirmed that markets should expect a non-representative LIBOR to be published only for “months, not years”.

In our previous blog post on The transition from LIBOR: FCA conduct risk warning and next steps, we predicted that ISDA would have another attempt to achieve market consensus on the question of pre-cessation triggers, in order to agree a single protocol (rather than having the option as to whether or not to incorporate pre-cessation fallbacks alongside permanent cessation fallbacks). It seems that ISDA and the regulators are hopeful that their clarification of the likely period of time for which a non-representative LIBOR will be published, will give market participants the comfort they need to adhere to a single protocol.

From a litigation risk perspective, a single protocol is likely to avoid different contracts switching away from LIBOR at different times, creating mismatches between different parts of a portfolio.

However, if such a consensus is reached, some market participants may be concerned at the loss of flexibility in how to address LIBOR cessation across the entirety of their contracts. This may discourage some market participants from adhering to the protocol at all. Moreover, the decision to re-consult will mean delay to the amendments to the 2006 ISDA Definitions which were supposed to be published in the first half of 2020. This delay is likely to be frustrating for market participants who are trying to progress their LIBOR transition projects, particularly financial institutions with large volumes of legacy LIBOR contracts.