The International Swaps and Derivatives Association (ISDA) has launched a market-wide consultation on potential money market fallback rates for derivatives contracts worth trillions of dollars. The move is the latest step in the almost decade-long effort by authorities around the world to draw a line under the price rigging scandals of rates such as the London InterBank Offered Rate (Libor) and Euribor rate that caused widespread uproar.
In a document released late on Thursday, the global industry derivatives body laid out five potential fallback rates and three ways of extrapolating overnight rates into longer-term ones that are used to price things such as mortgages.
It means those taking part in the consultation have nine combinations to chose from and list in order of preference. 1. Compounded Setting in Arrears Rate with Forward Approach 2. Compounded Setting in Advance Rate with Forward Approach 3. Spot Overnight Rate with Historical Mean/Median Approach 4. Convexity-adjusted Overnight Rate with Historical Mean/Median Approach 5. Compounded Setting in Arrears Rate with Historical Mean/Median Approach 6. Compounded Setting in Advance Rate with Historical Mean/Median Approach 7. Spot Overnight Rate with Spot-Spread Approach 8. Convexity-adjusted Overnight Rate with Spot-Spread Approach 9. Compounded Setting in Advance Rate with Spot-Spread Approach The consultation covers sterling LIBOR, Swiss franc LIBOR, yen LIBOR, TIBOR, euro/yen TIBOR and the Australian Bank Bill Swap Rate.
ISDA said it will run for three months, be open to all market participants rather than just derivatives specialists and that it would launch extra consultations covering USD LIBOR, EUR LIBOR and EURIBOR at a later date.
"Having robust fallbacks for derivatives contracts that reference an IBOR is critical for the stability of the financial system," ISDA Chief Executive Scott O'Malia said in the statement.
"If an IBOR permanently ceases to exist, it is vital that market participants have certainty that their existing IBOR contracts will fall back to a robust and clearly defined reference rate."
The need for fallback plans comes at a crunch time for money markets. Authorities are calling for banks to move away from benchmarks that were at the centre of scandals or that have been found to based on insufficient numbers of actual trades.
On Thursday, Britain's markets watchdog said banks must show how they plan to shift from using LIBOR in financial contracts to "risk-free" interest rate benchmarks by the end of 2021. The euro zone had also set a January 1 2020 start date for new euro-based benchmarks or reformed versions of current ones.
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