EurexOTC Clear: Transition plan for transactions referencing the CHF, GBP, JPY and USD LIBOR benchmarks

1.  Introduction

This circular contains information with respect to the service offering of Eurex Clearing AG (Eurex Clearing) regarding the following topics:

A.    Intention to actively convert OTC Clear IRS and basis swaps referencing CHF, GBP, JPY and USD LIBORs before index cessation date

B.     Treatment of LIBOR-based Forward Rate Agreements and USD LIBOR-based Swaps with stubs relying on 1W and 2M fixings

The timelines for the amendments to the legal framework of Eurex Clearing related to A. and B. will be communicated with subsequent circulars.

2.  Required action

The intended conversion of LIBOR portfolios in CHF, GBP, JPY and USD as well as the necessary amendment of clearing eligibility of the announced instruments may have an impact on clearing participant’s internal processes and positions. Therefore, it might be necessary for clearing participants to update their internal processes and technical interfaces to take these proposed changes into account.

3.  Details 

On 4 December 2020, ICE Benchmark Administration Limited (IBA) published a consultation on its intention to cease publication of the following:

• CHF, GBP, and JPY LIBOR overnight/spot next, 1W, 1M, 2M, 3M, 6M and 12M fixings and 1W and 2M USD LIBOR fixings effective on 31 December 2021. 
• Overnight/ spot next 1M, 3M, 6M and 12M USD LIBOR fixings effective on 30 June 2023. 

Based on IBA’s consultation results, on 5 March 2021, the Financial Conduct Authority announced the cessation and/or loss of representativeness of all of the above LIBOR fixings effective on the dates as indicated in the consultation.

On 23 October 2020, ISDA announced the launch of the IBOR Fallbacks Supplement to the 2006 ISDA Definitions which became effective on 25 January 2021. In this supplement, ISDA amended certain “Floating Rate Options” in the 2006 ISDA Definitions to include fallbacks that would apply upon the permanent discontinuation of certain key IBORs and upon a non-representativeness for LIBOR.

To keep in line with bilateral market practice, Eurex Clearing introduced amendments to its index cessation regime for OTC transactions. In particular, Eurex Clearing reflected the core provisions of this ISDA IBOR Fallbacks Supplement in its Clearing Conditions which became effective on 25 January 2021, as published in Eurex Clearing Circular 112/20.

The key fallback provisions introduced in this context ensure contractual continuity in case of an index cessation and are an important safety net of the transition process. However, the fallback trades following those provisions will differ from standard risk-free rate (RFR) OIS trades (as having “observation period shift”, simple spread and no payment delay), making them illiquid and not nettable with standard RFR OIS trades. Applying these fallbacks as a final step of the transition would pose challenges to Eurex Clearing because a CCP unwinding such legacy positions in the event of Clearing Member default would not be beneficial in ensuring market stability as well as to the Clearing Members that are required to submit bids to any DM Auctions, as the transactions resulting out of such auctions would not be nettable against their future RFR OIS-based portfolios. 

Therefore, with this Eurex Clearing circular, Eurex Clearing announces its intention to actively convert IRS and basis swap trades referencing LIBORs before the respective index cessation date (see under A.) and introduces changes to its Clearing Conditions and FCM Regulations to limit eligibility of certain LIBOR-based IRS Swaps and of certain LIBOR-based FRAs (see under B.).

A. Intention to actively convert OTC Clear IRS and basis swap referencing CHF, GBP, JPY and USD LIBORs before index cessation date

While inviting its Clearing Members and their clients to proactively transition their LIBOR-based portfolios to RFR, Eurex Clearing sees its responsibility in ensuring efficient risk management. Therefore, Eurex Clearing has the intention to actively convert the remaining cleared legacy LIBOR-based IRS (including FRAs) and basis swap trades to standard and liquid RFR OIS trades before the fallback provisions are triggered as follows:
 

It is envisaged that the converted RFR trades will preserve the original observation period and have a payment delay in line with standard OIS conventions, and no “observation period shift” as would be the case with the fallback provisions. 

To keep a consistent approach across cleared markets, Eurex Clearing intends to add a fixed tenor dependent spread to the converted RFR transactions where the spread is calculated as a median of the five-year historical differences between the LIBOR fixings and the respective compounded RFR for the same period.  

A one-off cash compensation on trade level will be introduced to mitigate the associated residual change in net present values between the LIBOR trades and the respective converted RFR OIS trades. 

Notable exceptions from the conversion include LIBOR vs LIBOR basis swaps, where Eurex Clearing intends to introduce a cash settlement on the Conversion Date instead of a conversion. 

Upon completion of the conversion, LIBOR floating-rate references in the respective currencies will no longer be eligible for the EurexOTC Clear service.  

In this context, the “Conversion Date” shall be the date on which Eurex Clearing pursues a legal and operational conversion of all OTCClear IRS trades referencing the respective LIBOR rate for a given currency and tenor to standard convention RFR OIS swaps. Eurex Clearing will announce such date as well as all necessary operational, methodological and legal details of the conversion upon availability and in due course. Eurex Clearing intends to conduct the conversion before the respective index cessation date.

In this context, please see also the results of Eurex Clearing’s consultation on its transition plan for OTC transactions referencing the EONIA benchmark, as published in Eurex Clearing circular 111/20.

B. Treatment of LIBOR-based Forward Rate Agreements and USD LIBOR-based Swaps with stubs relying on 1W and 2M fixings

Although ISDA offers a guidance on fallback provisions for non-linear products, the suggested provisions for Forward Rate Agreements (FRAs) have a backward-looking nature and are only known at the end of the interest period, which makes them incompatible with the traditional FRAs paying out at the start of the period. After an index cessation event and following ISDA’s guidance on fallback provisions, the default structure of an FRA would be that of a Single Period Swap requiring the implementation of a trade conversion process. Due to the incompatibility of the fallback provisions with the nature of FRAs, as well as expected diminishing liquidity of such instruments after FCA’s announcement on the future cessation or loss of representativeness of all LIBORs, Eurex Clearing will revoke the clearing eligibility of FRAs referencing CHF, GBP, JPY LIBOR and/or USD LIBOR with an expiry on or after 1 October 2021 and of FRAs referencing USD LIBOR with an expiry on or after 1 April 2023. 

Single period swaps (as a FRA substitute) continue to be eligible for clearing as part of Eurex Clearing’s service offering. Eurex Clearing further notes that the clearing eligibility of EUR EURIBOR FRAs remains unchanged by this announcement.

Related to FCA’s announcement on IBA’s cessation of 1W and 2M USD LIBOR fixings from 31 December 2021, Eurex Clearing will further limit eligibility of USD LIBOR-referencing IRS Swaps with expiry on or after 1 October 2021, if the swaps contain stub periods relying on 1W or 2M USD LIBOR fixings with or without linear interpolation being specified. 

Unless the context requires otherwise, terms used and not otherwise defined in this circular shall have the meaning ascribed to them in the Clearing Conditions or FCM Clearing Conditions of Eurex Clearing AG, as applicable.

Further information