Overview

On 11 June 2021, ISDA published the 2021 ISDA Interest Rate Derivatives Definitions (the "2021 Definitions") to replace the widely used 2006 ISDA Definitions and its associated supplements (the "2006 Definitions"). The 2021 Definitions are expected to become the market standard definitions for interest rate derivatives from the 'go live' date of 4 October 2021. ISDA definitions contain important product level terms that are typically incorporated into parties' transaction confirmations.

The 2021 Definitions consolidate the supplements to the 2006 Definitions into a single 'main book' - this seeks to address concerns that the 2006 Definitions have become unwieldy, owing to the volume of supplements which must be read alongside the main booklet (numbering 76 at the time the 2021 Definitions were first published). Various substantive changes have been made as part of the update too, in response to industry comments and to align the definitions with current market practice. Certain ancillary documents and matrices accompany the main book.

The 2021 Definitions are ISDA's first set of 'digitally native' definitions, published through ISDA's online 'MyLibrary' platform (as opposed to paper or pdf format). Subsequent amendments will be incorporated directly into a new consolidated version of the definitions, rather than via standalone supplements. Users will be able to compare different versions of the 2021 Definitions within the 'MyLibrary' platform, and it is possible for parties to incorporate a specific version of the definitions into their transaction documents.

Market participants will be able to continue using the 2006 Definitions if they wish, even after the go live date for the 2021 Definitions. The 2006 Definitions will no longer be supplemented after the go live date, however, and certain trading or clearing systems may require new transactions to incorporate the 2021 Definitions after the go live date. ISDA are considering whether to publish a protocol which amends adherents' legacy transactions (by replacing the 2006 Definitions with the 2021 Definitions) but no decision has been reached at the time of writing.

The remainder of this article outlines some of the main changes made in the 2021 Definitions.

Cash settlement methods

What are cash settlement methods and how are they changing?

Cash settlement methods determine the cash settlement amount payable by one party to another under certain interest rate derivatives transactions. The methods are used where the parties themselves are unable to agree on the relevant cash settlement amount by the relevant cut-off time and day. The obligation to pay a cash settlement amount typically arises upon the optional or mandatory early termination of interest rate swap transactions or the exercise of interest rate swaptions.

ISDA have rewritten or removed most of the cash settlement methods included in the 2006 Definitions, to address concerns that the existing methods were imprecise (and therefore a potential source of disputes) and did not reflect current market practice. The 2021 Definitions now feature seven cash settlement methods, five of which are variants of the new 'mid-market valuation' or 'replacement value' methods, explained further below. The remaining two cash settlement methods (namely, 'Collateralized Cash Price' and 'Par Yield Curve - Unadjusted') are legacy methods that are substantially unchanged from the versions set out in the 2006 Definitions.

Parties may either select their preferred cash settlement method in their transaction confirmation or, if not, rely on the method specified in the revised settlement matrix as being applicable to the relevant transaction type (which is expected to become the de facto market standard).

Mid-market valuation

The 2021 Definitions contain three cash settlement methods which adopt a mid-market valuation ("MMV") approach: 'Mid-Market Valuation (Indicative Quotations)' ("MMV-IQ"), 'Mid-Market Valuation (Indicative Quotations - Alternate Method)' ("MMV-IQAM") and 'Mid-Market Valuation (Calculation Agent Determination)' ("MMV-CAD").

Each MMV approach aims to obtain a clean theoretical value for the relevant transaction, based on the net present value of the transaction cash flows. Valuations are obtained either via indicative quotations provided by reference dealers (if MMV-IQ or MMV-IQAM applies) or via a determination performed by the calculation agent (if MMV-CAD applies). In either case, indicative quotations or calculations must be reached using the 'Prescribed Methodology' set out in the 2021 Definitions. This requires:

• any price, rate or value to be at the mid-point between the relevant bid and offer rates;

• the transaction to be deemed to be governed by a market standard master agreement that may (depending on the applicable elections) be either uncollateralised or collateralised;

• the discount factors used to calculate present value to be calculated from a zero-coupon curve, adjusted to take into account an agreed or standardised discount rate (if uncollateralised) or the key terms of a credit support annex (if collateralised);

• no adjustments to be made to any present value to reflect credit, regulatory capital or cost of funding considerations; and

• the assessment of any present value to have regard to whether the transaction cash flows are payable only upon the satisfaction of a contingency (e.g. an interest rate swap contingent upon another transaction coming into effect) and, if so, the likelihood of that contingency occurring.

The main difference between MMV-IQ and MMV-IQAM is that under MMV-IQ indicative quotations are typically requested by the calculation agent from reference dealers selected by the calculation agent, whereas under MMV-IQAM each party selects three reference dealers and requests indicative quotations from those reference dealers. That said, where MMV-IQ applies the party not acting as the calculation agent (the 'non-calculation agent') can still influence which reference dealers are selected and how quotations are requested - see the section 'Calculation agent, reference dealer and quotation procurement provisions' below.

If MMV-IQ or MMV-IQAM apply but fewer than two indicative quotations have been obtained, the value will be determined in accordance with MMV-CAD. Such determination will be made by the calculation agent if MMV-IQ was applicable, or by each of the parties separately (with the value being the average of the two amounts so determined) if MMV-IQAM was applicable.

MMV-IQ is specified in the settlement matrix as the default cash settlement method for all interest rate swap transactions for the purposes of optional or mandatory early termination.

Replacement value

'Replacement Value (Firm Quotations)' ("RV-FQ") and 'Replacement Value (Calculation Agent Determination)' ("RV-CAD") are the two other cash settlement methods introduced in the 2021 Definitions (albeit based on the legacy 'Cash Price' cash settlement method). As with the MMV approach, valuations are obtained either via quotations provided by reference dealers (if RV-FQ applies) or via a determination performed by the calculation agent in accordance with a prescribed process (if RV-CAD applies). In contrast however, the replacement value methods aim to determine the 'real life' cost of entering into a replacement transaction which replicates the material terms of the transaction in question. Where RV-FQ applies:

• each reference dealer is required to provide a firm (and not indicative) quotation representing the price at which it would enter the replacement transaction;

• the firm quotation must assume the replacement transaction is being entered with a 'Protected Party' - the identity of the Protected Party will vary depending on the context in which the valuation is being sought (and can be both parties);

• the firm quotation must assume the replacement transaction is governed by the 'Prescribed Documentation', which will typically be the master agreement in place between the reference dealer and Protected Party or, if none, a 2002 ISDA Master Agreement and cash-only credit support annex;

• each reference dealer may include any adjustments it ordinarily includes for equivalent transactions, including adjustments to reflect credit, regulatory capital or cost of funding considerations; and

• the value must be the best quotation available from the Protected Party's perspective.

The alternative RV-CAD method follows the process under Section 6(e) of the 2002 ISDA Master Agreement, determined as if the transaction were collateralised under a cash-only credit support annex (unless the master agreement between the parties is uncollateralised) and various other assumptions applied.

Floating rate options and the floating rate matrix

When determining a floating amount payable under parties' transactions, a key component of the calculation is the floating rate option: this is where the parties agree the benchmark or price source from which a floating rate may be obtained and the time and date at which the rate should be taken. In the 2006 Definitions, the various floating rate options which parties could select (e.g. USD-LIBOR-BBA) were listed in a 'narrative' format (in a paragraph of text). The 2021 Definitions removed the floating rate options from the main booklet and instead list the various floating rate options in a tabular matrix format (the floating rate matrix). The key specifications for each floating rate option are set out in separate columns.

Each floating rate option will also now be determined by reference to data published by a single administrator or central bank specified in the floating rate matrix. As such, there will no longer be several different floating rate options referencing alternative publication sources (e.g. Reuters or Bloomberg screen pages) for the same rate.

Fallbacks

A significant issue for the financial markets in recent years has been how to select an alternative 'fallback' rate where a benchmark used to determine a floating rate is no longer available for a particular fixing, given the discontinuation of certain major interbank offered rates. The 2021 Definitions address this by including a framework for selecting an alternative benchmark when certain non-publication or cessation-related events occur in respect of a benchmark. Such fallback provisions may be 'bespoke' or 'generic'. Users must refer to the floating rate matrix to ascertain which fallback provisions apply to each floating rate option.

The bespoke fallback provisions are designed with particular floating rate options in mind, so may prescribe fallbacks and adjustments that are only appropriate for the relevant floating rate. For example, if the administrator of a benchmark or relevant central bank has publicly recommended a successor benchmark, the bespoke fallback provisions may require that the parties apply such successor benchmark upon the permanent cessation of the original benchmark. The bespoke fallback provisions are based on the fallbacks specified in the ISDA 2020 IBOR Fallbacks Supplement to the 2006 Definitions.

The generic fallback provisions in the 2021 Definitions generally apply where no bespoke fallback is available. Such provisions set out a framework for selecting an alternative benchmark and adjusting the transaction terms upon the occurrence of certain temporary or permanent trigger events. The consequences of those trigger events vary depending on the trigger event in question. For instance, if a temporary trigger event occurs the relevant fallback will be determined using a different process to that applicable following a permanent cessation event (and the relevant fallback benchmark will only apply where the temporary trigger event is continuing). In the context of permanent cessations, the generic fallback provisions (which will apply unless an alternative is specified) require the parties to apply one of the following alternatives, in the order set out below:

• Bilaterally agree the actions to be taken to account for the relevant trigger event;

• If an alternative benchmark has been 'pre-nominated' by the parties in their transaction confirmation, adjust the terms of the transaction and pay any adjustment payment (or apply an adjustment spread) to account for the substitution of the original benchmark with the pre-nominated benchmark;

• If an alternative benchmark has been nominated by the applicable nominating body or administrator, adjust the terms of the transaction and pay any adjustment payment (or apply an adjustment spread) to account for the substitution of the original benchmark with such 'post-nominated' benchmark; or

• Adjust the terms of the transaction and pay any adjustment payment (or apply an adjustment spread) to account for the substitution of the original benchmark with a replacement benchmark determined by the calculation agent to be a commercially reasonable alternative.

In certain circumstances (including where no continuation fallback can be made) the transaction in question may be terminated. The generic fallback provisions are based on the 2018 ISDA Benchmark Supplement to the 2006 Definitions.

Calculation agent, reference dealer and quotation procurement provisions

The provisions governing the actions and determinations of the calculation agent, the selection of reference dealers and the procurement of quotations have been updated as part of the 2021 Definitions.

In general terms, the degree of discretion afforded to the calculation agent in the 2006 Definitions has been curtailed and replaced by more prescriptive terms intended to foster more objective decision-making and/or a greater degree of input from the non-calculation agent. Similar changes have been made to the provisions governing the selection of reference dealers and the procurement of quotations. In particular, under the 2021 Definitions:

• The calculation agent is required to act or make determinations in good faith and using commercially reasonable procedures to produce a commercially reasonable result. This tracks the wording in the close-out provisions in the 2002 ISDA Master Agreement, and moves away from the requirement in the 2006 Definitions for the calculation agent to act in good faith and in a commercially reasonable manner.

• Certain new procedural requirements apply to the calculation agent when making determinations. One key example is the requirement for the calculation agent to produce a 'Calculation Statement' in respect of a determination as soon as reasonably practicable following a request. This statement must show, in reasonable detail, any calculations made in connection with the determination, and must include market data relied upon by the calculation agent for such purposes. The calculation agent must therefore be prepared to disclose how its determinations were reached, potentially within short timeframes.

• Where the parties cannot agree on the appointment of reference dealers, the non-calculation agent may, by the delivery of a 'Selection Notice', select either a minority or half of the required reference dealers - the number varies depending on the circumstances in which the selection is being made. A consultation obligation has also been included, requiring the calculation agent to consult with the other party in relation to the selection of reference dealers where practicable.

• Quotations must be requested from reference dealers using a specific pro forma quotation request template (and determined by the reference dealers following the more prescriptive provisions outlined above). The non-calculation agent may elect to request quotations from up to two of the reference dealers (save where MMV-IQAM applies), as opposed to relying on the calculation agent doing so.

• The minimum number of quotations for dealer polls in the context of cash settlement has been reduced to two. This is intended to increase the likelihood of a dealer poll being successful, thereby reducing the likelihood of falling back to calculation agent determination.

• Specific dispute resolution processes are included in the 2021 Definitions in connection with the cash settlement and generic fallback provisions.

Questions?

For further information on the 2021 Definitions, please speak to your usual Simmons & Simmons contacts or any of the contacts named in this article.