ISDA publishes Version 2.0 of the ISDA Collateral Agreement Interest Rate
Definitions and three templates for amending interest rates in collateral agreements
Background
- There is a global regulatory desire for an increased number of products to refer to near risk free rates (RFRs). In this context, EuroSTR and SOFR are ‘new’ RFRs for the USD and EUR markets.
- For EUR, the rate displayed on the EONIA screen is currently EuroSTR plus 8.5 basis points. EONIA is anticipated to cease being published from 3 January 2022. This means that market participants will need to assess the extent to which contracts that refer to EONIA need to be remediated before January 2022.
- For USD, given the desire to increase liquidity in SOFR, over time an increasing number of products are expected to refer to SOFR rather than other US overnight rates such as Fed Funds.
- In the context of cleared derivatives, in July 2020 central clearing houses changed the rate at which interest is paid on EUR denominated cash collateral from EONIA to EuroSTR. We will see a similar change in October 2020, when the interest rate for USD denominated cash collateral will change to SOFR.
- In the context of uncleared derivatives, the ARRC has recommended that market participants amend interdealer collateral agreements to use SOFR by end-2020. It is expected that client facing collateral agreements will follow suit.
Collateral Agreement Interest Rate Definitions
- Unlike for other aspects of ISDA documentation, there has not been a standardised approach taken to how interest rates for the purposes of cash collateral are expressed in ISDA published collateral agreements for variation margin.
- Given the increased focus on robustness of contractual fallbacks as well as the expectation that the rates used for EUR and USD denominated cash collateral will be updated to refer to EuroSTR and SOFR respectively, in April 2020 ISDA published Version 1.0 of the Collateral Agreement Interest Rate Definitions.
- Version 1.0 contained definitions for EONIA and EuroSTR.
- In August 2020 ISDA published Version 2.0 of the Collateral Agreement Interest Rate Definitions.
- Version 2.0 now contains definitions for the RFRs in nine currencies, namely AONIA for AUD, CORRA for CAD, SARON for CHF, both EONIA and EuroSTR for EUR, SONIA for GBP, HONIA for HKD, TONA for JPY, SORA for SGD and SOFR for USD.
- Except for EONIA(1) and SORA(2), the triggers and fallbacks for the RFRs are intended, as far as possible, to follow the same approach taken for fallbacks to the RFRs that will be adopted in the ISDA IBOR Fallbacks Supplement and IBOR Fallbacks Protocol, which will be effective later this year.
- This is because the fallbacks in the ISDA IBOR fallbacks documents have been reviewed by a number of central banks and other regulators and so represent the latest thinking on RFR related fallbacks.
- By incorporating the Collateral Agreement Interest Rate Definitions into collateral agreements, parties can include in their collateral agreements standardised definitions relating to overnight interest rates with fallbacks that apply if the relevant collateral rate is permanently discontinued or temporarily fails to be published.
- Parties can adopt different approaches to incorporating the Collateral Agreement Interest Rate Definitions into both new and existing collateral agreements:
> A specific version: this means that the rates within the collateral agreement defined by reference to the Collateral Agreement Interest Rate Definitions will remain static, i.e. will not be automatically updated to reflect any changes to the RFR in subsequent versions of the Collateral Agreement Interest Rate Definitions. However, parties will have the ability to only update interest rates if they are comfortable with the updates within the subsequent version.
> As amended from time to time: this means that the rates within the collateral agreement defined by reference to the Collateral Agreement Interest Rate Definitions will update automatically to reflect any changes to the RFR in subsequent versions of the Collateral Agreement Interest Rate Definitions. This will not affect other rates in that collateral agreement which are not defined by reference to the Collateral Agreement Interest Rate Definitions.
> As amended from time to time with “Interest Rate Override: All Rates” applicable: the interest rate override means that if parties have specified a rate in their collateral agreement, which - was not within scope of the Collateral Agreement Interest Rate Definitions at the time of incorporation but is within scope of a subsequent version, then the rate set out in the subsequent version will automatically replace the rate as defined in the collateral agreement. This feature was particularly useful for the expected update from Version 1.0 to Version 2.0, when market participants were aware that the range of rates covered would be broadened.
- We expect to see the Collateral Agreement Interest Rate Definitions used in new collateral agreements as well as in existing collateral agreements, in particular where the parties wish to update the rates for EUR and USD cash collateral to EuroSTR and SOFR respectively.
Template Amendment Agreements
- In order to facilitate the update of EUR and USD interest rates in existing collateral agreements, ISDA published the following template forms of amendment agreement in August 2020:
> Template Form of Bilateral Agreement for amending references to EUR Interest Rates in Credit Support Documents,
> Template Form of Bilateral Agreement for amending references to USD Interest Rates in Credit Support Documents, and
> Template Form of Bilateral Agreement for amending references to EUR Interest Rates and USD Interest Rates in Credit Support Documents.
- These agreements are similar in format and vary depending on whether the parties wish to only change the EUR interest rate, the USD interest rate or both the EUR and USD interest rates at the same time. The approach may vary depending on whether only one of EUR and USD is an eligible currency with the relevant collateral agreement and also whether, even though both currencies are included as eligible currencies, parties deliberately want to stagger the updates to the EUR and USD interest rates.
- There are sixteen ISDA published collateral agreements within scope of the template form of templates. These broadly represent the various forms of variation margin collateral agreements published by ISDA since 1994. The ISDA published initial margin documents are not included on the basis that they do not generally contemplate an overnight interest rate for cash collateral being specified.
- Parties can vary the scope of the agreements covered by:
> expanding it to cover other ISDA published or non-ISDA published documents by specifying them as Additional Credit Support Documents;
> contracting it by excluding documents from the sixteen listed documents by specifying them as Party Agreed Excluded Credit Support Documents; or
> replacing the sixteen listed documents with a specified list by specifying Specified Credit Support Documents as applicable and listing the applicable documents.
- The templates contemplate the updated interest rate taking effect either at the start of the interest period following the effective date of the amendments, or during an interest period. In the latter case, parties will need to elect whether they want the updated rate to apply from the start of or part way through the interest period.
- Given that the interest rate levels may be different (for example, EuroSTR is 8.5 basis points lower than EONIA), the templates contemplate the payment of compensation. However, it is for the parties to determine whether compensation should be payable and, if so, how it should be determined.
- All of these templates, together with the Template Form of Bilateral Agreement for amending references to EONIA in Existing Agreements and Credit Support Documents published in April 2020, will be available on ISDA Create.
- ISDA Create is the online solution built by Linklaters’ internal technology start-up Nakhoda that automates the process of producing, negotiating and agreeing documentation and enables the capture of valuable structured legal data. For more information on ISDA Create, please contact support@isdacreate.org.
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