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Buy-side perspective: IBOR transition and derivatives

Buy-side perspective: IBOR transition and derivatives
  • United Kingdom
  • Financial services and markets regulation - Derivatives


All buy-side firms will soon be required to end their reliance on interbank offer rates (“IBORs”).

IBORs are the foundations on which much of the global financial markets are built. Over time however, cracks in these foundations have appeared and global regulators have decided the time for repair is now.

Wide-spread reliance on IBORs means that transition projects that firms must undertake will be amongst the most significant in recent memory and regulatory pressure is building for buy-side firms to demonstrate progress.

In this briefing we examine the particular legal and regulatory issues faced by buy-side firms when transitioning their IBOR referencing derivatives. We also provide an update regarding IBOR transition, including proposed tax and accounting relief in the United States and regulatory guidance given yesterday (21 November 2019) in the United Kingdom.


Derivatives referencing IBORs have been a feature of the global financial markets since the 1980s. Since their introduction, the volume of IBOR referencing derivatives has continued to grow. Today there is approximately US$ 4 trillion in notional exposure to IBOR referencing derivatives transactions globally.

After decades as the dominant benchmark, global regulators have decided that, due to flaws with IBOR, long-term reliance on it is no longer viable. These flaws include IBOR’s vulnerability to misconduct and a lack of actual transaction data to verify the rates (as, following the financial crisis, the unsecured interbank market is used less frequently for bank funding).

Global regulators have therefore taken steps to replace IBORs with risk-free rates (“RFRs”). Whereas IBORs are determined using expert judgement, RFRs are calculated using actual transaction data from active markets. The differences in calculation methodology means that the flaws inherent in IBORs are not characteristics of RFRs.

In the United Kingdom, the Financial Conduct Authority (the “FCA”) has stated that it will no longer compel or persuade panel banks to submit data for the calculation of sterling LIBOR into 2022. This has had the effect of creating a clear deadline for market participants to end their IBOR reliance.

Global regulators, including the FCA, have made clear that they expect the buy-side to take active steps to transition from IBORs to RFRs now.

Development of RFRs

In February 2013, the G20 instructed the Financial Stability Board (the “FSB”) to undertake a review of the major interest rate benchmarks and plans for reform in order to ensure that these plans where consistent and co-ordinated and that the benchmarks used were robust and used appropriately. In July 2014, the FSB published a report recommending the development and use of RFRs.

Various working groups were established in order to identify appropriate RFRs for different markets. These working groups have now identified the RFRs. A summary of the different RFRs are set out in the table below.




Secured/ Unsecured

Working Group

The state of the rate



Sterling Overnight Index (SONIA)


Working Group on Sterling Risk-Free Reference Rates

SONIA has been used since March 1997. A reformed SONIA was published in April 2018. SONIA swaps trading is approaching 50 per cent. of the market.

There is a liquid market for swaps and futures based on SONIA.

US dollar


Secured Overnight Financing Rate (SOFR)


Alternative Reference Rates Committee (“ARRC”)


SOFR was first published in April 2018. SOFR futures become available for trading in May 2018. Clearing in SOFR-referencing swaps began in October 2018.

This week ISDA recorded the 1000th SOFR-swap transaction in the year to date, but SOFR swaps are still a very small part of the US dollar swaps market.



Tokyo Overnight Average Rate (TONAR)


Study Group on Risk-Free Reference Rate

First published on 1 November 1997.

Swiss franc


Swiss Average Rate Overnight (SARON)


National Working Group on Swiss Franc Reference Rates

SARON was first published in August 2009. SARON swap clearing has been available since October 2017. SARON futures have been available for trading since 29 October 2018.



Euro Short Term Rate (€STR)



Working Group on Euro Risk-Free Rates

€STR is a replacement rate for the Euro Overnight Index Average (EONIA).

EURIBOR is currently being reformed. Though an €STR based fall back is being developed and may eventually replace EURIBOR.

IBORs and RFRs: What’s the difference?

There are a number of fundamental differences between IBORs and RFRs. Buy-side firms will need to consider these differences carefully in order to understand whether changes to their systems and processes are needed in order to transition to RFRs.

We have identified some of the key differences that firms should consider below.



Based largely upon expert judgement.

Based only upon transaction data in active markets.

Forward-looking rates.

Backward-looking rates calculated using historic transaction data.

Available in multiple tenors.

Overnight rate only currently but term rates are in development.

Incorporate a bank credit risk premium.

Do not incorporate a bank credit risk premium.

A liquidity premium is applied to longer term rates.

No liquidity premium is applied.

Issues for buy-side firms

IBORs are ubiquitous feature of the financial markets. For firms that participate in those markets, any change to the IBOR will impact their legal documents, operations and business activity. Any transition away from IBORs will therefore generate a host of issues that firms will need to consider at each stage of the transition process.

What should buy-side firms do to address these issues?

Buy-side firms should now have established a formal transition program to deal with IBOR cessation. Firms should ensure that the program has a robust governance structure with appropriate profile and resource. The program involves the following steps in relation to the transition of derivatives contracts:

Step 1:


Firms should take steps to identify the use of IBOR in their derivatives contracts (in particular those with a stated maturity beyond the end of 2021).

Step 2:


Wherever it is viable to do so, firms should enter into transactions that reference RFRs rather than IBORs. Firm should also consider amending legacy transactions that reference IBORs to instead refer to relevant RFRs.

Step 3:


Firms should ensure that the documentation governing IBOR referencing transactions include appropriate contractual fallbacks (i.e. contractual terms that set out what happens if an IBOR ceases to be available).

We describe some particular issues and challenges that firms will face at each stage of the transition process below.

Step 1: Identify

Buy-side firms will be required to identify IBOR-referencing derivatives within their portfolio with an outstanding term that extends beyond the anticipated date of cessation of the relevant IBOR. This exercise will likely form part of a wider process to develop an inventory of products and contracts referencing IBORs.

Firms should also review existing derivatives documentation, including netting agreements and collateral agreements to ensure that any references to IBORs are modified or supplemented as needed.

Step 2: Transition

Firms should consider taking steps to (i) enter into transactions that reference RFRs rather than IBORs wherever possible in the future and (ii) amend existing transactions that refer to IBORs to refer to RFRs instead. The transition process is, however, likely to present a number of material issues for firms.

Firms should monitor the progress made by quantifying IBOR exposure. Firms should familiarise themselves with key publications by the FSB, the Official Sector Steering Group and individual working groups.

In the United Kingdom, regulatory pressure is increasing for new sterling interest rate swaps to reference SONIA rather than sterling LIBOR and for use of SONIA to become the market convention from the first quarter of 2020.


The challenges faced by a number of buy-side firms (such as asset managers) include a lack of liquidity in the markets in derivatives referencing RFRs. Many of these markets are still new and it is difficult to project how quickly these markets will become as deep as those referencing IBORs as this will depend upon market uptake.

Many firms have a duty to their clients to transact in liquid markets. If the markets in RFRs have insufficient liquidity, a tension may arise with this duty. Buy-side firms should give this tension due consideration before migrating transactions to reference RFRs where liquidity is thin. The ability of firms to enter into transactions in RFRs will also depend, to an extent, upon the ability of trading and clearing services to support transactions in those instruments.

Credit risk spread adjustments

When parties replace a reference to an IBOR with the relevant RFR in an existing transaction, the bank credit risk premium element of the rate will be removed. In order to preserve the economic equivalence of the new transaction, a spread adjustment may need to be applied as a proxy for the premium. ISDA requested market feedback in relation to the credit spread adjustment for various RFRs through multiple consultations.

On November 15, 2019, ISDA published a report summarising the feedback it received on its most recent Consultation on the Final Parameters for the Spread and Term Adjustment (the “Consultation”). This Consultation, which was launched in September of 2019, intended to finalise the methodologies for the adjustments that will be made to derivatives fallbacks in the event LIBOR and other IBORs are permanently discontinued, and followed two earlier consultations that also requested input on options for the adjustments to the relevant RFRs if fallbacks are triggered for derivatives referencing LIBOR and certain other IBORs.

The Consultation requested feedback on the adjustment spread methodology that should apply to the relevant risk-free rates, i.e., whether (i) a median over a five year lookback period or (ii) a trimmed mean over a ten year lookback period (in each case from the date of announcement/publication of information regarding cessation the relevant IBOR) should apply. The Consultation also requested feedback on potential approaches for implementing the compounded setting in arrears rate approach, i.e., whether a delayed payment, a backward-shift, a lockout or a similar adjustment to avoid making payments on the same date as the date on which the fallback rate is known would be necessary.

A majority of respondents (61%) preferred an implementation of the spread methodology based on a historical five-year median approach (option (i) above). For the compounded setting in arrears rate, a majority (56%) favoured a two-banking-day backward-shift adjustment for operational and payment purposes.

ISDA is currently in the process of drafting fallback language to amend the 2006 Definitions that would apply upon the permanent discontinuation of an IBOR. ISDA is also developing a protocol to enable market participants to include such fallbacks into their legacy instruments (see below). ISDA will implement the results of this Consultation into its fallback language and protocol.

Both the fallback language and the protocol are expected to be finalised by the end of 2019, with implementation in 2020. An independent services provider appointed by ISDA (Bloomberg Index Services Limited) will calculate and publish the adjustments in relation to the fallbacks.

Development of term rates

RFRs are principally overnight rates. There are efforts across various markets to develop forward-looking term reference rates based on the alternative RFRs. These efforts are being led predominately by the cash markets.

IBORs are forward-looking rates with a number of different tenors. The forward-looking term structure of IBORs means that they can be used to calculate future contractual payments (e.g. interest) in advance at the beginning of an accrual period. As RFRs are backward-looking, the payment due can only be calculated at the end of the accrual period.

Demand for term rates is anticipated to be limited in the derivatives market. In the cash market however, where there is greater need for certainty in respect of future payments for budgeting and risk management purposes, demand is expected to be greater. Working groups are developing term rates. As the cash markets adopt any new term rates, exposures to such rates may need to be hedged. Derivatives contracts may therefore reference the term rate. Buy-side firms will therefore need to consider their hedging arrangements if the terms rates are used elsewhere in their business.

Various working groups (including The Working Group on Sterling Risk Free Reference Rates) have indicated that a forward-looking term rate could help facilitate transition from IBORs to RFRs. The FCA has, however, stated that waiting for term rates to be developed is not a reason to delay transition. The FCA has noted that the development of SONIA term rates is to be the central issue in a forthcoming Working Group on Sterling Risk-Free Reference Rates publication in relation to term rates.

Regulatory concerns

Firms should consider whether an amendment to the terms of their derivatives will mean that those derivatives no longer benefit from grandfathering arrangements and those derivatives therefore fall in-scope of certain regulatory requirements, for example under European Markets and Infrastructure Regulation. This might mean that an obligation to exchange margin or to report details of those derivatives to a trade repository might arise.

Tax and accounting

The transition from IBORs to RFRs is likely to have far-reaching tax and accounting consequences. In particular, transition is likely to impact hedge accounting where their hedging instruments, hedged risks and/or hedged items are indexed to an IBOR. Key questions also arise as to whether an amendment of hedge designations to refer to a new benchmark would be viewed as a de-designation of existing hedging arrangements and the designation of a new one or whether IBOR cash flows in longer-term cash flow hedges still have a highly probability of occurring.

The standard setters for the U.S. General Accepted Accounting Principles (U.S. GAAP) and the International Financial Reporting Standards (IFRS), the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), respectively, are aware of the uncertainty resulting from the transition and are considering relief. With respect to contract modification, the FASB has proposed to grant relief for loan, debt, lease and other contracts that reference an IBOR that will, or is anticipated to, cease to exist and for which the contract modifications are either essential to or related to the replacement of such interest rate benchmark. To the extent such relief is available, entities would not have to account for an extinguishment of the original contract and the formation of a new contract as a result of the IBOR transition. The FASB has also proposed relief for existing fair-value and cash flow hedging relationships by proposing that certain changes in connection with IBOR reforms would not result in the dedesignation of the hedging relationship.

In the United States, the Department of the Treasury and the Internal Revenue Service released proposed regulations providing guidance on the U.S. federal income tax consequences of changing reference rates in debt and non-debt instruments (e.g., swaps) to rates other than existing IBORs. The proposed regulations are generally consistent with expectations and provide that replacing the LIBOR with a “qualified rate” (including adding such rate as a fallback rate) will not be treated as a modification of an existing instrument. Provided that the fair market value requirement is satisfied and the rate is based on transactions conducted in the same currency as the prior IBOR, a “qualified rate” includes the identified RFRs and other rates to the extent such rate fits within the broad definition of any “qualified floating rate”. The fair market value requirement is satisfied only if the fair market value of the debt or non-debt instrument after the alteration is substantially equivalent to the fair market value of the instrument before the alteration, but this requirement may be satisfied through two safe harbours.

Step 3: Fallback

The FCA has indicated that the most favourable transition from IBORs will be one in which contracts that reference IBORs are replaced or amended before fallback provisions are triggered. If buy-side firms are unable to transition entirely from IBORs to RFRs prior to the date that the IBOR ceases to be available or a regulatory announcement is made that the IBOR is no longer representative, it should, as a minimum, ensure that appropriate contractual fallbacks are adopted.

What are fallbacks?

Fallbacks are terms in contracts that determine the “when?” and “what?” if a rate becomes unavailable.

  1. When does a fallback rate to apply?
  2. What is the fallback rate?

Existing fallbacks

Existing fallback provisions are designed for short-term interruptions to the publication of a rate rather than its complete cessation. As such, these existing fallbacks often rely upon a ‘dealer poll’ (a process of collating quotations from third party dealers in the relevant interdealer market). A dealer poll does not represent a viable long-term solution because, even if quotations were available in the near-term, it is unlikely that this would continue to be the case for a material length of time.

New fallbacks

As discussed above, ISDA is developing a contractual fallback solution intended to mitigate market disruption following the permanent discontinuance of key IBORs. As part of this solution, ISDA intends to publish a supplement to the current version of its definitions booklet for interest rate derivatives (the “Amended 2006 Definitions”). The Amended 2006 Definitions are expected to be published by the end of the year. After their publication, the Amended 2006 Definitions can be incorporated into new transactions. ISDA also intends to publish a protocol that will allow adhering parties to make multilateral amendments in order to apply the fallbacks to their legacy transactions. The Amended 2006 Definitions and protocol will become effective on the same date.

Firms will need to ensure that their systems and internal processes are compatible with the fallbacks prior to making the changes to their existing transactions.

A question of when: Pre-cessation triggers

There is increased clarity regarding the RFRs that will apply in place of specific IBORs. The question of when parties should switch from those IBORs to the relevant RFR however is uncertain. The FCA has recently suggested that firms consider switching rates when the FCA announces that LIBOR is no longer representative (because the number of submissions by panel banks reduces significantly but a number a small number of submitters remain) rather than at the time its ceases to be available.

In that case, IBORs might still be available for a period because reliance on an unrepresentative rate might be more favourable than an abrupt cessation in some markets where there is no mechanism for multilateral amendments available. This view is gaining momentum.

On 19 November 2019, the FSB wrote to ISDA to encourage the addition a pre-cessation trigger alongside the cessation trigger as standard language in the Amended 2006 Definitions for new derivatives and in a single protocol, without embedded optionality, for all outstanding derivative contracts referencing IBORs.

In relation to over-the-counter transactions, ISDA has consulted on whether or not to include pre-cessation triggers in the Amended 2006 Definitions, but has not yet announced whether it intends to include a pre-cessation trigger.

In relation to cleared transactions, a number of central clearing counterparties (“CCPs”) that clear IBOR swaps have stated that they would regard the loss of representativeness as a trigger to using the discretion in their own rulebooks to transition all of their cleared IBOR portfolios to the new RFRs, adjusted by the spreads identified by ISDA. Firms should therefore consider the impact on any hedges between uncleared and cleared derivatives. The FCA has noted that, given the prospective CCP actions when an IBOR is found unrepresentative, these hedges are likely to be best preserved if pre-cessation triggers are included in uncleared contracts too.

Cash market fallback language

In the United States, the Alternative Reference Rate Committee (“ARRC”), a group convened by the Federal Reserve Board and the New York Fed to develop USD LIBOR fallback language for cash market products, has published recommended language for new syndicated loans, bilateral business loans, floating rate notes, securitisations, and closed-end, residential adjustable-rate mortgages (“ARMs”). The recommended language inserts triggers, replacement rates, and spread adjustments into new USD LIBOR instruments. Unlike ISDA, the majority of the triggers for cash market products recommended by the ARRC include pre-cessation triggers.

The manner in which the replacement rates are selected (and, to some extent, the replacement rates themselves (e.g., an in arrears rate versus an in advance rate)) and the spread adjustments are calculated may differ also differ from the Amended 2006 Definitions. Accordingly, market participants that use derivatives to hedge exposures associated with cash market products may need to ensure that their hedges remain effective when adopting such language.


Firms are likely to wish to apply the fallback triggers and RFRs consistently across underlying cash products and derivatives entered into to hedge those products in order to prevent a mismatch. However, as described above, the approach taken across markets can differ and the fallback language across products is unlikely to be identical. Basis risk could emerge if derivatives and the cash products that they hedge transition to RFRs at different times.

ISDA Benchmarks Supplement

ISDA had already completed significant work in relation to contractual fallbacks in the context of the EU Benchmark Regulation (the “BMR”). Article 28(2) of the BMR requires EU supervised entities such as credit institutions, insurers, reinsurers, investment funds and pension schemes to produce and maintain robust written plans setting out the actions that they would take in the event that a benchmark materially changed or ceased to be provided. EU supervised entities are also required to, where feasible and appropriate, to nominate one or several fallback benchmarks if a referenced benchmark is no longer available or ceases to have the necessary regulatory approval or registration.

ISDA published the ISDA Benchmarks Supplement (the “Supplement”) on 19 September 2018. The Supplement covers a broad range of benchmark, including IBORs.

ISDA has also created the ISDA 2018 Benchmarks Supplement Protocol (the “Protocol”) to allow market participants to incorporate the Supplement into transactions. Since the Protocol was opened on 10 December 2018, there has been limited adherence by buy-side firms. The Supplement or the Protocol is, however, increasingly incorporated by reference into ISDA Master Agreements.

The new IBOR fallbacks which will form part of the Amended 2006 Definitions (described above) are a “Priority Fallback” for the purposes of the Supplement which means that, if incorporated into a transaction, the Amended 2006 Definitions will apply in priority to the terms of the Supplement following the permanent cessation of an IBOR. The Supplement will, however, apply to all transactions that incorporate the Supplement and the 2006 ISDA Definitions but not the Amended 2006 Definitions. As the Amended 2006 Definitions do not deal with a circumstance where a benchmark administrator ceases to be approved such that the benchmark can no longer be used. Therefore, if such an event occurs in respect of an IBOR, then the Supplement will continue to apply.

Under the terms of the Supplement, if an IBOR ceases to exist or a benchmark administrator ceases to be approved such that the benchmark can no longer be used and no Priority Fallback applies, the waterfall of fallbacks used to determine a replacement benchmark is as follows:

  1. A benchmark agreed between the parties.
  2. A benchmark nominated by the parties at the time of trading plus any payment or spread adjustment needed to account for the transfer of economic value from one party to another as a consequence of the change to the specified benchmark.
  3. A substantially equivalent benchmark nominated by the administrator or use of a benchmark nominated by a central bank or officially endorsed working group or committee plus any payment or spread adjustment needed to account for the transfer of economic value from one party to another as a consequence of the change to the specified benchmark.
  4. A benchmark nominated by the Calculation Agent plus any payment or spread adjustment needed to account for the transfer of economic value from one party to another as a consequence of the change to the specified benchmark.

If none of the fallbacks can be used, at that point affected transactions can be terminated applying the ISDA Master Agreement’s no-fault close-out calculation.

How can Eversheds Sutherland help?

Eversheds Sutherland, together with alternative, legal and compliance provider Konexo can guide firms through all of the steps needed to transition from IBORs to RFRs, including in relation to their legacy derivatives portfolio and future trading arrangements.

  1. Developing a strategy - Together Eversheds Sutherland and Konexo can work with you to develop project plans and offer strategic advice at each stage of the transition process.
  2. Keeping you updated - Eversheds Sutherland participates in numerous industry working groups and is therefore aware of the latest market developments. We can also work with you to ensure that that you are up-to-date with product developments and industry documentation initiatives and trends.
  3. Training your team - We can offer tailored training to relevant teams within your business.
  4. Efficient tech solutions - The firm offers AI solutions as a cost and time efficient way of identifying references to IBORs within contracts.
  5. Helping you keep track - We can also develop reports to help firms track progress.
  6. Helping you communicate with your clients effectively - We can also develop a client communication strategy (including documentation that can be used for client education).
  7. Global cross-product coverage - Eversheds Sutherland has a global presence in all of the major financial markets across all major products (including cash and derivatives) and offers buy-side firms a joined up solution across all products.