Financial Contract Fallback Rate (FC-FBR)
A Financial Contract Fallback Rate (FC-FBR) is a financial benchmark that specifies the rate to be used in financial contracts when the original interest rate benchmark is no longer viable.
- Context:
- It can be a critical component in the transition away from benchmarks like the LIBOR to alternative rates such as the Secured Overnight Financing Rate (SOFR).
- It typically comes into play following the permanent cessation of the original benchmark rate.
- It is determined through a pre-defined process or methodology, often involving a spread-adjusted compounded average of the alternative rate, calculated towards the end of the payment period.
- It has been developed and endorsed by financial industry bodies such as the International Swaps and Derivatives Association (ISDA) to ensure a smooth transition for existing financial contracts from LIBOR to alternative benchmarks.
- Example(s):
- Counter-Example(s):
- A Chatbot Fallback Rate,
- A direct replacement rate selected without the need for a fallback provision.
- Interest rates determined independently of any benchmark cessation event.
- Variable rates directly tied to an existing index.
- Prime Rate,
- Fixed Interest Rate,
- Interest Rate Swap.
- See: IBOR Transition, ISDA Protocol, Risk-Free Rate (RFR), Benchmark Reform, Benchmark Rate, Risk Management, Financial Conduct Authority (FCA).
References
2024a
- (ChatGPT-OpenAI, 2024) ⇒ Prompt: Summarize the concept Fallback Rate (FBR) in 1- 2 paragraphs. ChatGPT (model:gpt-4-turbo-preview). Retrieved: 2024-03-09.
- QUOTE: A Fallback Rate (FBR) is a contingency interest rate mechanism, usually embedded within financial contracts, that comes into effect if the primary interest rate index becomes unavailable or non-viable. This is particularly relevant in loan agreements, derivatives, and other financial instruments which rely on benchmark interest rates, such as the London Interbank Offered Rate (LIBOR), to determine interest payments. The necessity for FBRs has grown as some major benchmark rates have faced discontinuation or loss of reliability, prompting regulators and market participants to establish alternatives to ensure continuity and stability in financial markets.
The specifics of a Fallback Rate are typically outlined within the contractual terms of financial agreements. It provides a predefined method for calculating interest payments in the absence of the primary reference rate. Implementing FBRs involves identifying a substitute rate plus a spread adjustment to account for any differences between the original benchmark and the fallback. The transition to FBRs is crucial for minimizing market disruption and protecting the interests of all parties involved in financial transactions. As global financial markets evolve, the role of Fallback Rates becomes increasingly significant in maintaining the integrity and smooth functioning of financial instruments.
- QUOTE: A Fallback Rate (FBR) is a contingency interest rate mechanism, usually embedded within financial contracts, that comes into effect if the primary interest rate index becomes unavailable or non-viable. This is particularly relevant in loan agreements, derivatives, and other financial instruments which rely on benchmark interest rates, such as the London Interbank Offered Rate (LIBOR), to determine interest payments. The necessity for FBRs has grown as some major benchmark rates have faced discontinuation or loss of reliability, prompting regulators and market participants to establish alternatives to ensure continuity and stability in financial markets.
2024b
- (Chatham Financial, 2024) ⇒ https://www.chathamfinancial.com/insights/what-to-know-about-the-fallback-rate-sofr Retrieved: 2024-03-09.
- QUOTE: As the primary regulator of the U.S. Dollar London Interbank Offer Rate (LIBOR), on March 5, 2021, the Financial Conduct Authority (FCA) designated June 30, 2023, as the last date that LIBOR will be published on a representative basis. As the end of LIBOR is rapidly approaching, market participants should be prepared for the cessation’s impact across products. Under U.S. Law derivatives may not utilize synthetic LIBOR which will continue to be published on a non-representative basis by the FCA until September 2024.
What to know about Fallback Rate (SOFR)
To aid in the transition away from LIBOR, the International Swaps and Derivatives Association (ISDA) created the IBOR Fallbacks Supplement to define how legacy LIBOR derivative contracts will transition to the Secured Overnight Financing Rate. Uncleared derivatives referencing LIBOR will transition to the replacement index selected by ISDA and the Federal Reserve Board, Fallback Rate (SOFR), effective July 3, 2023.
- QUOTE: As the primary regulator of the U.S. Dollar London Interbank Offer Rate (LIBOR), on March 5, 2021, the Financial Conduct Authority (FCA) designated June 30, 2023, as the last date that LIBOR will be published on a representative basis. As the end of LIBOR is rapidly approaching, market participants should be prepared for the cessation’s impact across products. Under U.S. Law derivatives may not utilize synthetic LIBOR which will continue to be published on a non-representative basis by the FCA until September 2024.
2024c
- (LSEG Data & Analytics, 2024) ⇒ https://www.lseg.com/en/data-analytics/libor-transition-solutions/isda-ibor-fallback-rates. Retrieved: 2024-03-09.
- QUOTE: ISDA Fallback rates are relevant to derivatives trades referencing a specific IBOR and play a key role in the event of a permanent cessation of that interbank offered rate (IBOR). Specific fallback rates are set out in the 2006 ISDA Definitions. ISDA released robust Fallback rates that would apply in the event of a permanent cessation of a key interbank offered rate (IBOR).
2020
- (Youngman, 2020) ⇒ Douglas Youngman (2020). "A Closer Look at ISDA's New 2020 IBOR Fallbacks Protocol and Amendments to 2006 Definitions". In: Holland & Knight Alert.