October 22, 2018

International Swaps and Derivatives Association, Inc.
(via Email: FallbackConsult@isda.org)
Comments on the Consultation on Interbank Offered Rate (IBOR)
Fallbacks for 2006 ISDA Definitions
Dear Sirs/Madams:
We, the Japanese Bankers Association (JBA), would like to express our gratitude for thisopportunity to comment on the consultation on Interbank Offered Rate (IBOR) Fallbacks for2006 ISDA Definitions (the Consultation) published on July 12, 2018 by the International
Swaps and Derivatives Association (ISDA).
The JBA is an organization whose members consist of approximately 200 banks
operating in Japan and abroad.
We respectfully expect that the following comments will contribute to your furtherdiscussion.
1. General Comments(1) Impact of developing forward-looking term rates
Working groups in U.K. and other jurisdictions have initiated discussion on term rates
for respective currencies. Once robust forward-looking term rates are established, they may bereferenced in various products and it is expected that the hedging needs will arise.
Although we recognize it is the intention of the Financial Stability Board (FSB) Official
Sector Steering Group (OSSG) that the fallbacks could work without the development offorward-looking term rates, we believe that ISDA should carefully consider how thedevelopment of forward-looking term rates will have impacts on the fallbacks for derivatives.
(2) Retention of economic value
It is preferable to retain economic value of an existing transaction after triggering afallback. Under the spread adjustment methodologies other than the forward approach
proposed in the Consultation, the present value of a transaction will change when the fallback
rate is applied to the transaction instead of the original reference rate. This would cause an1

impact on profits and losses. In addition, there is an issue that subsequent changes after
applying the fallback in the market condition would not be reflected in the fallback rate.
(3) Consideration to cash products hedged by derivatives
While derivatives are independent financial transactions, many of them are used for thepurpose of hedging cash products and are managed together with those cash products. Theusers of those derivatives include many non-financial institutions (i.e. end users) that haverelatively limited measures. From the perspective of ensuring the soundness of derivatives
markets, these hedgers that have actual demand for derivatives are essential market
participants.
Therefore, although the Consultation excludes the fallbacks in non-derivatives products
from its scope, the fallbacks’ compatibility with cash products should be taken into account.
Specifically, ISDA should consider the documentation that takes into account compatibility
with cash products in addition to the language related to interbank derivatives transactions.
The Consultation regarding fallbacks for syndicated business loans published by theAlternative Reference Rates Committee (ARRC) on September 24, 2018, also indicates thatcash product fallbacks may differ in some respects from derivative fallback provisions1.
As for the proposed approaches for adjusted risk-free rates (RFR), the hedge
effectiveness could not be ensured other than in the compounded setting in arrears rate
approach. In particular, it would be difficult to convince end users of the appropriateness of thefallback rate unless the hedge effectiveness, etc. is ensured for existing transactions even after
the fallbacks are applied.
(4) Timing of finalization and implementation
According to ISDA’s FAQ, the 2006 ISDA Definitions will be amended in the latter halfof 2019. Given a situation where there is a concern over the permanent discontinuation ofLIBOR, we understand that ISDA sets this schedule to provide clarity and certainty to market
participants in the event of permanent IBOR discontinuation. However, the following two
viewpoints are important from practical standpoints, and we expect that in finalizing thisamendment ISDA will carefully consider these as well as the timeline regarding the potential
cessation of LIBOR.
a. Development of term rates
If this amendment is finalized as is proposed, it means that the fallback rate for1

See “C. Differences between Proposed Fallback Provisions for Cash Products and Derivatives” of ARRC CONSULTATIONREGARDING MORE ROBUST LIBOR FALLBACK CONTRACT LANGUAGE FOR NEW ORIGINATIONS OF LIBORSYNDICATED BUSINESS LOANS.
(https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2018/ARRC-Syndicated-Business-Loans-Consultation.pdf)

2derivatives may be different from a fallback rate for other products, which can be a
forward-looking term rate. In that case, the hedge effectiveness cannot be ensured between
such derivatives and cash products when the fallbacks are triggered. This can have an adverse
effect on the liquidity of the derivatives market.
b. Preparation of infrastructures for including fallback provisions into contracts
When including fallback provisions by amending contracts, it is preferable that thefollowing conditions are satisfied. To fulfill these conditions, it is necessary to have anappropriate preparation time.
・ The market of derivatives referencing a fallback rate such as Overnight Index Swap
(OIS) is as liquid as that of the interest rate swaps referencing existing IBORs.
・ End users understand and recognize the fallback rates sufficiently.
・ Financial institutions have in place an appropriate framework for revenue
management and risk management.
2. Answers to the Questions(1) Preferred Approach● Please rank the combinations listed above with 1 as your preferred approach, 2 as yoursecond preferred approach, and so forth.
○ Please explain your rankings. Please specifically comment on the characteristics ofthe combinations you ranked the highest that most influenced your decision.

(Answer)
In conclusion, we have decided not to rank the pairs of adjusted RFR and spreadadjustment because we are aware of many concerns to be solved.
(Rationale)
It is important to take into account the following three points when discussing thefallbacks.
i) The fallbacks should be compatible with current practices given that many
derivatives are used as hedge instrument for cash products.
ii) Adjustments should be made to reflect actual market conditions.
iii)The fallbacks should retain the present economic value of transactions.
The JBA’s member banks have discussed the approaches proposed in the Consultationand many concerns were expressed from the viewpoints written above. If we were to choose
an approach for adjusted RFR and spread adjustment, we would be forced to choose one in anegative manner. Therefore, we concluded that it is not possible to rank the combinations
listed in the Consultation.
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○ Indicate whether your preferences apply universally to GBP LIBOR/SONIA; JPY
LIBOR/TONA; TIBOR/TONA; Euroyen TIBOR/TONA; CHF LIBOR/SARON andBBSW/RBA cash rate.
○ If your preferences apply universally, please indicate whether you would also expect
your preferences to apply to USD LIBOR/SOFR, EUR LIBOR/[the identified EUR
RFR] and EURIBOR/[the identified EUR RFR].

(Answers)[Multi-currency transactions]
The fallback approach in transactions involving multiple currencies, in particular, should
be consistent across currencies, including USD and EUR (differences in the timing ofconsultation should not result in different treatment of the fallbacks for USD and EUR).
It is not realistic to change the adjustment approach according to currencies because itwould multiply the workload to prepare for fallbacks.
Furthermore, in the case of currency swaps referencing the IBORs of two currencies,
applying different approaches for the fallback will impact the valuation and pricing.
Price comparison between currencies is currently relatively easy because the portion of
the yield curve relying on current IBORs is built upon common concepts and on/off-balance
sheet transactions are priced based on such a yield curve. If the concepts vary between
currencies, price comparison will become difficult, which may undermine or distort themarket’s pricing function.
[Single-currency transactions]The footnote to the Consultation states that “however, this consultation does not exclude
the possibility of a market participant electing to use TIBOR as the fallback for JPY LIBOR.”
Based on the statement, we believe that TIBOR may be selected as the fallback rate for JPY
LIBOR through bilateral negotiations.
From a practical viewpoint, however, there are some issues to be solved for theadjustment of differences between IBORs. We therefore expect ISDA to discuss technicalmeasures for adjusting such differences. Similar issues may arise for EUR, which is not in thescope of the Consultation.

[Other requests concerning currency]
While the Bank Bill Swap Rate (BBSW) is frequently used for AUD-denominated4transactions in market practice, the Bank Bill Swap Bid Rate (BBSY) is frequently used in
Sydney as a benchmark rate for loans. We request ISDA to consider a fallback rate for BBSY
as well, because currently BBSY is defined only by referencing the screen.
● Please indicate whether you would not be able to transact using definitions that incorporate
fallbacks based on any of the approaches to adjusted RFRs or spread adjustments. If you
would not be able to transact, please give specific examples of the types of derivatives forwhich the fallbacks would be problematic and explain why.

(Answers)[Major concerns for transactions applying the compounded setting in arrears rate
approach]Given that many transactions are currently executed based on forward looking fixing ofrates, applying the compounded in arrears rate approach will require accumulation of interest
rates during the compounding period, and result in changing interest rate receipt/payment
operations significantly, which is expected to impose significant burdens on operation andsystems.
[Specific examples of transactions]・ There may be some cases (for example, in LIBOR in arrears swap) where it is unable
to complete the fixing in time for floating rates payment.
・ Trust banks as trustee for investment trust funds currently reconcile with theinvestment management company the amount of accrued interest that is accumulated
on a daily basis at the time when calculating accrued interest on the first day of theinterest rate swap, and then transfer journal entry data from the executed trade
management system to the accounting system. If the compounded in arrears rate
approach is applied, they will need to consider fundamentally modifying their current
flow or making operational changes.

5● Please provide separate comments on the general appropriateness and effectiveness of each of the four approaches to adjusted RFRs andthree methodologies for the spread adjustments. Please specifically comment on anticipated operational challenges, economic impacts,implications for hedging, feasibility of implementation and any other complexities. Indicate whether your comments apply to all contracts, newcontracts only or legacy contracts only. With respect to any operational challenges, please explain how long it would take to overcome suchchallenges.

(Answer)
As previously mentioned, it is preferable that the followings are met: (1) the fallbacks should be compatible with current practices
given that many derivatives are used as hedge instrument for cash products; (2) adjustments should be made to reflect actual marketconditions; and (3) the fallbacks should retain present economic value of transactions. The table below summarizes our analysis on theRFR adjustment and the spread adjustment from these three viewpoints.
In conclusion, with respect to the RFR adjustment, the compounded setting in arrears rate is the preferable approach as it reflects
actual market conditions. With respect to spread adjustment, the forward approach would be the preferable approach so long as data are
available. However, from a realistic viewpoint, the historical mean/median approach could be an option as well. Nonetheless, eachapproach has issues to be addressed as below, and this conclusion is reached only in a negative manner.
[RFR adjustment](1) Compatibility with current(2) Adjustments reflecting actual(3) Retention of present

practicesmarket conditions

economic value of transactions

Spot Overnight

Compatible

Not accurately reflect actual

There are gaps in the present

The fixing risk is elevated andRate-The interest rate is set inmarket conditions.

value of transactions referring

adverse effects on the market areadvance at the beginning of-existing IBORs and that of

expected due to reliance on theThis approach would mean

6(4) Others

(1) Compatibility with current(2) Adjustments reflecting actual(3) Retention of present

practicesmarket conditions

economic value of transactions

the term of the interest rate.

that an overnight rate that doestransactions referring fallback

not have term structure will berates.

applied to every term.

-(4) Others

interest rate on a specific date.

An overnight rate that does not

The hedge effectiveness could be

have a term structure will be

undermined if the term forapplied to every term.

referencing interest rate differs
between the hedged item and thehedging instrument.

Convexity-adjusted

Compatible

Not accurately reflect actual

There are gaps in the present

Difficult to earn end users’

Overnight Rate

-The interest rate is set inmarket conditions despite

value of transactions referring

understanding due to complexity.

advance at the beginning ofconvexity adjustments.

existing IBORs and that of

The hedge effectiveness could be

the term of the interest rate.

-This approach would meantransactions referring fallback

undermined if the term for

However, due to thethat an overnight rate that doesrates.

referencing the interest rate differs

complicated formula, this rate

not have term structure will be-

An overnight rate that does not

between the hedged item and thecould only be used as aapplied to every term.

have a term structure will behedging instrument.

Furthermore, convexity is notapplied to every term.

-

fallback and is not expected to-

be widely used as a base ratenecessarily calculated

for new contracts. As a result,appropriately as the formula

this will give rise to market

does not rely on interest ratebifurcation.

volatility. Therefore, thisapproach does not produce
enough benefits to justify the7(1) Compatibility with current(2) Adjustments reflecting actual(3) Retention of present

practicesmarket conditionseconomic value of transactions(4) Others

complexity of the calculation
method.
Compounded

Not compatible

The most preferable option

Not possible to completely retain

Setting in Arrears-Shifting from the interest rate

among the four approaches fromthe present value of transactions

set in advance to the interest

the perspective of reflecting actual

because the timing of fixings

rate set in arrears is expectedmarket conditions.

differs from that of IBORs.

Rate-to impose significant burdens
on a wide-range of users, andhave significant effects inpractice, such as necessity tounify terms and conditions incontracts entered into withcustomers.
Compounded

Compatible

Historical rates may deviate from

There are significant gaps in theThe hedge effectiveness could be

Setting in Advance-The interest rate is set in

actual market conditions if market

present value between transactions

undermined because historicaladvance at the beginning ofconditions are highly volatile due

referring existing IBORs and thatinterest rates are referenced.

the term of the interest rate.

to such events as interest rateof transactions referring fallbackhikes.

rates as historical interest rates areRatereferenced.

8[Spread adjustment]

Forward(1) Compatibility with current(2) Adjustments reflecting actual(3) Retention of present

practicesmarket conditions

economic value of transactions-This approach is vulnerable toMinimization of value transfer

Vulnerability to manipulations

manipulations and distortions in

can be expected at the time whenand distortions in the market

the market and the availability of

fallbacks are triggered since this

could be mitigated to a certain

appropriate data is uncertain.

approach reflects expected market

extent by collecting historical data

Furthermore, this approach isprices. This however could notof respective tenors and using theirdependent on model selection, etc.

retain the economic value of theaverage, etc. However, this is

as data used are not directlytransactions before triggering theunrealistic because it requires

observable in the market.

fallback because subsequent

additional tremendous amount ofchanges in the markets are notmarket data.

Approach(4) Othersreflected.
Historical-

It is relatively insusceptible to

Value transfer will occur.

This approach can avoid cliff

Mean/Medianrecent market manipulations,-This approach does noteffects and thus stable spreads canApproach

depending on the determination ofnecessarily reflect actual

be expected.

an appropriate period.

market conditions at the time
when fallbacks are triggered
appropriately as it makes
adjustments using the averageof historical prevailing market
rates.

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(1) Compatibility with current(2) Adjustments reflecting actual(3) Retention of present

practicesmarket conditions

economic value of transactions-(4) Others

Furthermore, this could not
retain the economic value ofthe transactions before
triggering the fallback becausesubsequent changes in themarkets are not reflected.

Spot-SpreadApproach-This approach is highly vulnerable

Value transfer is significantly

Other than a benefit of data

to market manipulations before

susceptible to changes in market

availability, we do not see any

the fallback triggered.

conditions at the time when theadvantages over the historicalfallback is applied

mean/median approach.

-This approach only reflects
recent market prices.

-

Furthermore, this could not
retain the economic value ofthe transactions before
triggering the fallback because
subsequent changes in themarkets are not reflected.

10(2) General● How important or unimportant is it for the fallbacks to be approximately present-value
neutral at the time of trigger? Please explain why.

(Answer)
It is important for the fallbacks to be present-value neutral from the perspective ofretaining the economic value of contracts.
(Rationale)
When applying the fallbacks, it is important that pre-fallback economic value isunchanged after the fallback is triggered. However, every approach proposed in theConsultation is not capable of retaining economic value as noted in this letter. The final
document should specify this point.
● How important or unimportant is it for the fallback rates to be available in advance ofthe accrual period. Alternative, is setting in arrears acceptable? Please explain whyor why not.

(Answer)
Taking into account the compatibility with current practice, it is important for thefallback rates to be available in advance of the accrual period. The setting in arrears might beacceptable, though it is necessary to give particular consideration to end users for the reasons
written in the “Rationale” below.
(Rationale)
As mentioned above, the users of derivatives transactions for hedging purpose include
many non-financial institutions (end users) that have relatively limited measures. If it isdifficult for such users to select the setting in arrears as the fallback rate for hedged assets, it ispossible that they will not select the setting in arrears as a fallback rate in order to ensure thecorrelation between the reference rate of a hedged asset and that of a hedging instrument.
● How important or unimportant is it for the fallback rates to be wholly (or mostly)
convexity free? Please explain why or why not.

(Answer)
It is important from the perspective of appropriately capturing actual market conditions.

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