The fallback language consists of three key components: the fallback trigger event, the replacement of the benchmark, and the adjustment of the reference point replacement. In addition to fallback language, companies must consider other important contractual characteristics that may affect the IBOR transition, including the due date, the company`s role in the contract, the use of benchmarks, modification and consent, applicable law and jurisdiction, and force majeure provisions. To address this issue, industry associations are working to develop strong fallback provisions for IBOR listing transactions. For over-the-counter (OTC) derivatives, ISDA plans to amend the definitions in ISDA 2006 – or any new transactions once they are implemented. ISDA will also provide a protocol for counterparties to implement a robust fallback language for legacy transactions. For cash products, national working groups such as the U.S. ARRC have issued proposed fallback language to implement new IBOR-related transactions. Based on the analysis, a global systemically important bank (G-SIB) may have more than 250,000 contracts with references to URIBs that are likely to expire after 2021, in addition to several thousand other contracts with indirect IBOR risk (e.g. B a penalty clause in agreements with suppliers).1 The volume of documents can increase significantly when activities such as service, when companies may not have a direct financial commitment, but play an important operational role in IBOR contracts. It is estimated that the legal and contractual correction for the IBOR transition can cost more than $50 million and would require skills in contract discovery, digitization, term extraction, redeployment, customer contact, and enterprise-wide communication. Third, for all new transactions related to IBOR, a robust fallback language must be introduced to limit the potential legal and behavioral risk that will continue to be introduced with each new IBOR-based transaction. Finally, organizations must systematically capture and store fallback language for all legacy and new transactions, confirming that fallback language can be used by operating systems in the event of a termination event (called “operational fallback language”). The legal correction strategy associated with the transition will influence the companies` customer contact and communication approach, operational readiness and, ultimately, the product transition strategy.
Failure to address contractual challenges can have negative consequences for financial market participants, including financial, legal, behavioural and reputational risks. “Fallback language” refers to contractual terms that determine the process by which a replacement rate can be identified when a benchmark (e.B LIBOR USD) is not available. In other words, the back-up wording of a contract serves as a practical guide for identifying replacement rates (hereinafter referred to as `benchmark replacement` or `replacement rate`) in the event that the initial benchmark is not available. The unprecedented scale of the transition from IBOR to ARR should not be underestimated and poses significant challenges to the industry. To ensure a smooth transition of IBOR, companies must manage legal and contractual issues, fallback language, and their strategy for new products and legacy transactions. The London Interbank Offered Rate (LIBOR) has been widely used as a benchmark rate in a range of financial products and instruments for over 40 years – exposure to LIBOR is estimated at over $400 trillion. The Financial Conduct Authority (FCA) has announced that it will not require banks to file LIBOR quotes after 2021. Given the increased risk of LIBOR expiry, financial market participants are accelerating their efforts to move from LIBOR to other reference interest rates (RARs). In financial contracts, robust fallback language is needed to enable a smooth transition in the event of a benchmark termination. By “robust,” we mean language that provides a clear and actionable path to the replacement of benchmarks, which is probably not the language found in most contracts today.
In addition, capturing the fallback language and operationalizing the fallback language may require changes to more than 200 applications that are internal and internal to the vendor. First, to facilitate a smooth and orderly transition and proactively manage business and competitive risks, companies should be able to offer “new” RAR-related products, tools and services in a timely manner and in line with evolving market conventions. Robust fallback language should also be introduced in new transactions that refer to ARs From the outset to ensure that these transactions are not exposed to the same benchmark hiring risks in the future. We see many challenges in the language of historical relief. Typically, it was written to provide an interim solution in case an interest rate is temporarily unavailable, rather than considering a permanent suspension of the benchmark. .
