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Derivatives Have a LIBOR Solution – Treasury and Risk

A sweeping agreement designed to prevent turmoil from being unleashed in the global derivatives market when LIBOR expires is gaining widespread acceptance.

Nearly 14,000 parties have agreed to sign on to the International Swaps and Derivatives Association (ISDA) protocol, according to the organization. The pact allows for the London interbank offered rate (LIBOR) to automatically be yanked from hundreds of trillions of dollars of interest-rate swaps, futures, and options and replaced with another rate, addressing a major risk hanging over markets as the discredited benchmark’s end nears. While it doesn’t completely rule out the potential for disruption, the protocol goes a long way toward ensuring a smooth transition.

“The ISDA protocol has been a resounding success in de-risking the derivatives market,” said Tom Wipf, chair of the Alternative Reference Rates Committee (ARRC), the Federal Reserve–backed group guiding the transition. “People’s biggest concern was asymmetric take-up. There are very few household names or big players in the market that haven’t adhered.”

Entities accounting for almost 95 percent of gross notional outstanding cleared and uncleared swaps have signed on to the ISDA protocol, according to February data by the U.S. Commodity Futures Trading Commission (CFTC). In the U.K., 97 percent of sterling interest-rate derivatives were covered by fallbacks as of January, according to the Financial Conduct Authority (FCA).

“Market participants can press on with active transition of their portfolios, taking into account the most appropriate alternatives for hedges and specific products, safe in the knowledge that a workable and clear backup will take effect if they aren’t able to transition away from all of their LIBOR exposures,” Ann Battle, head of benchmark reform at ISDA, said by email.

Barclays Plc, Goldman Sachs Group Inc., JPMorgan Chase & Co., and Credit Suisse Group AG are among the major banks that have signed on to the agreement. There’s close to $280 trillion worth of swaps being traded in five LIBOR-linked currencies, according to data from the Bank for International Settlements (BIS) covering the first half of 2020.

Even with the safety net now in place, it’s still an open question about how it’ll all work in practice. Some experts say that the boilerplate language in the legal documents might not cover every situation and that some holdouts remain.

Firms who sign the ISDA protocol could be locked into interest-rate risk that’s difficult to hedge, or they could be forced to use the Secured Overnight Financing Rate (SOFR), the main LIBOR replacement, instead of a better alternative, according to Hanif Virji, founder of Vivadum Ltd., a financial services litigation consultancy.

Some hedge funds “may still be doing the math to figure how they feel about it,” said Anne Beaumont, a partner at law firm Friedman Kaplan Seiler & Adelman LLP. “If you’re an investment manager, you have a fiduciary duty to not blindly amend your contracts.

“You’re going to want to at least go through the process of evaluating what the process means,” she added.

—With assistance from Alexandra Harris.


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