The Isda Collateral Agreement Interest Rate Definitions

Additional overnight interest rates can be added in subsequent iterations and are differentiated by various release dates and version numbers. Information on the three methods of adopting definitions can be found in the preamble. The EONIA Protocol is a multilateral amendment mechanism that allows market participants to replace references to the average of the European Overnight Currency Index (“EONIA”) in their guarantee agreements with references to the euro short-term interest rate (“€STR”) plus a spread of 8.5 basis points. The change in the reference interest rate will take effect when the publication of the EONIA ends on January 3, 2022. The EONIA protocol also includes fallback solutions in contracts falling within the scope that apply in the event of a permanent shutdown of €STR. > as amended: This means that the interest rates in the guarantee agreement, defined by reference to the interest definitions in the guarantee agreement, are automatically updated to reflect changes to the DFR in later versions of the interest rate definitions in the guarantee agreement. This does not affect other interest rates in this Guarantee Agreement that are not defined by reference to the definitions of interest rates in the Guarantee Agreement. On the euro market, the reform of two generalized key interest rates is underway. The interest rates that are the subject of these reforms are as follows: Definitions of collateral rates have been prepared by ISDA in the context of efforts to shift markets from interbank supply rates (“IBOR”) to other risk-free interest rates (“RFR”) and broader benchmark reforms. General information on hiring IBOR and developing RFR can be found in our previous briefing “Perspective buy-side: IBOR transition and derivatives”. Signatories to the EONIA Protocol should ensure that they are comfortable with the number of treaties falling within the scope of the EONIA Protocol. In particular, the parties should consider whether €STR plus a spread of 8.5 basis points is the appropriate replacement rate in the context of certain collateral arrangements.

In February 2018, the European Money Market Institution (“EMMI”), which acts as the administrator of EONIA, announced that EONIA will not comply with the requirements of the EU Benchmark Regulation (the “EU BMR”) when these requirements come into force on 1 January 2022. Subsequently, the liquidation of EONIA began, and on the 13th. In September 2018, the Working Group on Risk-Free Euro Interest Rates (the “Euro Working Group”) recommended €STR as the interest rate to replace EONIA. The EONIA Protocol contains certain provisions of version 2.0 of the Interest Rate Definitions of ISDA Guarantee Agreements (the “Definitions of Guarantee Rates”) in all “Documents covered by the Protocol” between the acceding parties. The EONIA Protocol replaces references to EONIA in the documents provided by the Protocol with references to the definition of “EONIA (Collateral Rate)” in the Collateral Rate Definitions. For more information on collateral rate definitions, see our previous briefing: Overnight Feel: ISDA Releases New Definitions to Ease EONIA Transition. The first version of the interest rate definitions of the ISDA Guarantee Agreement contains definitions of EONIA (guarantee rate) and EuroSTR (guarantee rate). The second version contains slightly modified versions of these definitions, as well as definitions of CORRA (warranty rate), SARON (warranty rate), SONIA (warranty rate), HONIA (warranty rate), TONA (warranty rate), SORA (warranty rate), and SOFR (warranty rate). If the parties wish to apply the version of the definitions of coverage rates in effect from time to time, they may expressly provide for this in the warranty agreement. Alternatively, the parties may apply the derogation mechanism contained in the definitions of the guarantee package. The substitution mechanism can be applied either to a specific interest rate or to all interest rates. When the replacement mechanism is applied, the fallback solutions contained in the latest version of the definitions of the collateral set shall be applied, regardless of when the collateral arrangement was executed.

The definitions of guarantee rates provide an opportunity to comply with the recommendations of the Euro Working Group on Robust Fallback Language for Euro Cash Interest Rates. Although the recommendations of the Euro Working Group are not legally binding, they represent the dominant consensus in the market and therefore widespread adoption of definitions of interest rates on collateral, which can be determined by the seller, is to be expected. If the parties have already amended an ancillary agreement that would otherwise fall within the scope of the EONIA Protocol to include fallback solutions with respect to EONIA, that ancillary agreement does not fall within the scope of the EONIA Protocol. For example, ancillary agreements under New York or England and Wales law involving an entity not established in the EU do not fall within the scope of Article 23a of the €STR, first published on 2 September. October 2019, is the interest rate that reflects the borrowing costs of euro area banks on the unsecured wholesale market and is prepared by the European Central Bank. €STR is considered a more accurate and robust interest rate than EONIA for a number of reasons, summarized in the following table: The definitions of guarantee rates indicate that the inclusion of guarantee rate definitions does not affect the application of the negative interest rate protocol of the ISDA 2014 guarantee agreement (the “negative interest rate protocol”) to guarantee contracts. In particular, the definitions of collateral interest rates clarify that the indication of the modified €STR as the applicable interest rate does not constitute a `spread determination` for the purposes of the negative interest rate protocol. The inclusion of a spread clause in a collateral arrangement may mean that the agreement does not fall within the scope of the Negative Interest Rate Protocol. Companies that have old references to EONIA in their guarantee contracts should ensure that these references are replaced by references to €STR, €STR modified or another appropriate successor rate before 3 January 2022. Fallback provisions in guarantee rate definitions provide companies with a standardized way to achieve this.

However, companies should carefully consider whether fallback solutions, including those that apply to €STR, are right for them. In particular, undertakings should take into account the economic impact of any change in their spot interest rates, including the possibility of transferring an economic value that could result from a change in the applicable interest rate. Even if these are ancillary agreements between two EU-based entities, it is not clear whether the laws in force in some jurisdictions would be considered an orderly liquidation of EONIA (since EONIA would not fall within the scope of the strict inheritance of New York or the United Kingdom). This definition of EONIA (Collateral Rate) provides that on 3 January 2022 (or an earlier date when it will be announced that EONIA will no longer be available), the relevant interest rate is €STR plus a spread of 8.5 basis points (reflecting the existing EMMI methodology for the calculation of EONIA, as mentioned above). The definitions of guarantee rates also offer fallback solutions that apply when €STR is no longer available. Collateral agreements published by ISDA (including, inter alia, the 2016 Credit Support Annex for margin of variation (VM) and the 1995 ISDA Credit Support Annex) between two parties are documents provided by protocol for the purposes of the EONIA Protocol. . . .

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