LIBOR End Game Enters Next Phase With New Derivatives Protocol

LAGOS (Capital Markets in Africa) — The global migration away from the London interbank offered rate hit a critical juncture Friday, with a new legal protocol opening the way for a wider adoption of alternative benchmarks.

The International Swaps and Derivatives Association, or ISDA, unveiled standardized contractual language, which will allow firms that haven’t fully prepared for Libor’s exit to incorporate transition clauses into their agreements.

Lawyers say the move by the trade group that oversees the global derivatives industry will accelerate the shift away from the discredited interest-rate benchmark, which has been gathering pace in recent days.

Firms including Barclays Plc, Goldman Sachs Group Inc., JPMorgan Chase & Co., and Credit Suisse AG, as well as the Bank of England, have already signed up tothe new framework.

In October, clearing houses shifted interest-rate swaps on more than $80 trillion in notional debt to the Secured Overnight Financing Rate, or SOFR, Libor’s main replacement rate in the U.S, substituting the effective federal funds rate in calculations that value the securities.

Libor, which is used to price trillions of dollars of derivative products worldwide, is due to be phased out by the end of 2021. Regulators began winding down the benchmark after European and U.S. banks were found to have manipulated rates to benefit their own portfolios.

ISDA’s new legal protocol will help companies avoid complicated renegotiations or a cliff-edge scenario as the deadline approaches. Watchdogs including the U.K.’s Financial Conduct Authority have said the derivatives protocol will play a key role in retiring Libor.

Still, there are concerns that the boilerplate language won’t serve all companies’ best interests. Banks face greater regulatory pressure and maybe quicker to adopt the new protocol, forcing smaller clients to get in line.

“Banks have a lot of leverage,” Anne Beaumont, partner at Friedman Kaplan Seiler & Adelman, said before the announcement. “They can say ‘if you don’t adhere, we are not interested in doing business.’ I would expect the banks to adhere first and then tell their customers to get with the program.”

Another problem is that the protocol doesn’t set dates for the switchover, according to Kate Dawson, who works on banking conduct and capital markets at KPMG, one of the world’s biggest auditing firms.

“If you want complete certainty, we’ve heard people say, you need to transfer your contacts to a risk-free rate and not rely on a fallback,” she said.

CME Group Inc. said Thursday that trading volume in SOFR futures and swaps reached record levels in recent days. Firms cleared $84 billion in SOFR swaps in October-to-date, a 185% increase over September, CME said in a statement.