Below is our summary answer.
First a couple of definitions:
ISDA new fallback: compounding setting in arrears with 2 days composition period shift and historical median over 5-year lookback period.
CCPs new fallback: ISDA new fallback, once and how adopted by the CCPs (small variations possible).
New trades: Trades done after the introduction of the new definitions (expected in 2020).
Vanilla IBOR swaps
- Cleared
- Legacy and new trades: CCPs new fallback
- Uncleared
- Legacy trades: Current fallback no fit for purpose, possibility to sign protocol to use ISDA new fallback. Cost of signing the protocol to be determined (see short story and Quant Insights 2019 presentation). New fallback changes the forward rates (fixed spread).
- New trades: ISDA new fallback.
- Note: For some almost vanilla swap, like IMM swaps, the ISDA fallback is not achievable for all coupons, even with the 2-day composition period shift. For those trades (legacy and new), fallback to be agreed bilaterally.
FRA
- Cleared: New ISDA fallback not fit for purpose, fallback at the sole discretion of the CCPs, no mechanism proposed yet.
- Uncleared:
- Legacy and new trades: New ISDA fallback not fit for purpose, to be agreed bilaterally.
- Alternative: Physical settled OIS (see description here)
Cap/floor
- Cleared: not cleared at any CCP
- Uncleared:
- Legacy trades: Current fallback no fit for purpose, possibility to sign protocol to use ISDA new fallback. Cost of signing the protocol to be determined. New fallback changes the forward rates (fixed spread) and the option type (European to Asian)
- New trades: Asian options instead of European
- Alternative term sheet for new trades (potentially for legacy trades with a new protocol): European options with physical settled OIS (see description here)
Swaptions
- Cleared: Short term optionality at CME, very illiquid. CCPs new fallback.
- Uncleared
- Physical delivery of a cleared swap: CCPs new fallback.
- Cash settlement: No fallback for the ICE swap rate, currently no solution. Note that cash settlement with collateralised price is impacted by the change of discounting mechanism at CCPs in 2020.
- Alternative: Change cash settlement with collateralised price to physical settlement at CCP. Require assessing the impact on valuation (forward, volatility, discounting).
ED futures and options
- CME: Fallback to SOFR futures, generally in line with the ISDA fallback for swaps (compounding and spread). Difference on the underlying period (IMM v LIBOR 2 days shifted). Some comments here.
- Other CCPs: no official proposals yet
Deliverable swap futures
- No official proposal yet
- Alternative: Create OIS risk-based futures (as proposed in white paper Risk-Based Overnight-Linked Futures Design).
Don't hesitate to contact us for more details on our research and tools related to the LIBOR fallback for OTC and ETD derivatives.