7 minute read 11 Mar 2021
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How to address the legal and contractual challenges of IBOR transition

By EY Global

Ernst & Young Global Ltd.

7 minute read 11 Mar 2021

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Learn 10 actions to help overcome legal and contractual issues, and remediate legacy transactions associated with the IBOR transition.

The London Interbank Offered Rate (LIBOR) has been used extensively as a reference rate in a range of financial products and instruments for more than 40 years – exposure to LIBOR is estimated to be more than $400t. The Financial Conduct Authority (FCA) announced that it will not compel banks to submit LIBOR quotations after 2021. With the heightened risk of imminent discontinuation of LIBOR, financial market participants are accelerating their efforts to transition from LIBOR to Alternate Reference Rates (ARRs). This transition is expected to be one of the most significant changes for the financial services industry. The unprecedented scale of this industry-wide transition will pose considerable challenges, including potential financial, legal, operational, conduct and reputation risk.

What is fallback language and why is it important for the IBOR transition?

“Fallback language” refers to the contractual provisions that lay out the process through which a replacement rate can be identified if a benchmark (e.g., USD LIBOR) is not available. In other words, the fallback language within a contract acts as a “how-to” guide for identifying replacement rates (hereafter referred to as “benchmark replacements” or “replacement rates”) should the original benchmark be unavailable. 

Fallback language comprises three key components: fallback trigger event, benchmark replacement, and benchmark replacement adjustment. In addition to the fallback language, firms will need to consider other key contractual features that may impact the IBOR transition, including maturity date, firm’s role in the contract, benchmark use, amendment and consent provision, governing law and jurisdiction, and force majeure provisions.

Robust fallback language is required in financial contracts to enable a smooth transition in the event of a benchmark cessation event. By “robust,” we mean language that offers an unambiguous and actionable path to benchmark replacement, which is likely not the language found in most contracts today. 

We see many challenges with historical fallback language. Typically, it was written to provide an interim solution should a rate be temporarily unavailable, rather than considering a permanent benchmark cessation. Even more concerning, fallback language often lacks clarity in selecting replacement rates and can result in economically undesirable outcomes and conduct and legal risk.

Language also varies between derivatives and cash products and, even further, between different cash products. This variation drives uncertainty, so firms may be faced with a contract-level review to determine how to remediate impacted transactions.  

To address this, industry bodies are working to develop robust fallback provisions for IBOR-referencing transactions. For over-the-counter (OTC) derivatives, ISDA plans to amend the ISDA 2006 definitions – or all new transactions once implemented. ISDA will also provide a protocol for counterparties to implement robust fallback language for legacy transactions. For cash products, national working groups, such as the US ARRC, have published proposed fallback language to implement new transactions referencing IBOR.

IBOR transition strategy across new products and legacy transactions

The IBOR transition strategy can be segregated into (1) the readiness to offer “new” products, instruments and services referencing ARRs, such as the secured overnight financing rate (SOFR) for USD LIBOR; and (2) the remediation of legacy transactions referencing IBOR that mature after 2021.

First, to facilitate a smooth and orderly transition and proactively manage business and competitive risks, firms should be able to offer “new” products, instruments and services referencing ARRs, in a timely manner and in line with evolving market conventions. Robust fallback language should also be introduced into new transactions referencing ARRs at the outset to make certain that these transactions are not exposed to the same benchmark cessation risks in the future. 

Second, for all legacy transactions or contracts with references to IBOR that mature after 2021, firms should define a clear transition strategy and roadmap. Depending on the transaction, client segment, contract type and provisions, transition strategies may include sale or exit, repricing (modifying the benchmark rate from an IBOR to an ARR, with an appropriate spread adjustment), amendment of fallback language, or no action.

Third, robust fallback language must be introduced for all new transactions referencing IBORs to cap the potential legal and conduct risk that continues to be introduced with each new IBOR-based transaction. 

And, finally, firms should systematically capture and store fallback language for all legacy and new transactions and confirm that the fallback language can be used by operational systems in the event of a cessation event (referred to as “operationalizing fallback language”).

Based on the analysis, a global systemically important bank (G-SIB) may have more than 250,000 contracts with references to IBORs that are likely to mature post-2021, in addition to several thousand other contracts with indirect IBOR exposure (e.g., a penalty clause in supplier agreements).1 The volume of documents can increase significantly when considering activities such as servicing, where firms may not have direct financial exposure but play an important operational role in IBOR contracts. It is estimated that legal and contract remediation for IBOR transition may cost more than $50 million and would require enterprise-wide contract discovery, digitization, term extraction, repapering, client outreach and communication capabilities.

Document intelligence solutions may offer a means of conducting this extensive review and cataloguing of contracts in an automated or semi-automated manner via technology such as optical character recognition (OCR) and artificial intelligence/machine learning (AI/ML). Solutions can be deployed to digitize vast numbers of contracts into machine readable formats, extract relevant terms via customizable business logic and interpret those terms into a structured data set for consumption. When faced with thousands or hundreds of thousands of impacted contracts, document intelligence solutions can significantly reduce document review and processing time, resulting in cost savings for firms. 

Moreover, capturing fallback language and operationalizing fallback language may require changes across more than 200 internal and vendor applications. 

The legal remediation strategy associated with the transition will influence firms’ client outreach and communication approach, operational readiness, and, ultimately, product transition strategy. The inability to address contractual challenges may result in adverse consequences for financial market participants, including financial, legal, conduct and reputation risk.

What can firms do now?

  1. Actively monitor and participate in fallback language consultations and product conventions led by national and industry working groups
  2. Implement robust fallback language (transition event, benchmark rate and spread adjustment) in all new cash transactions referencing IBORs and ARRs
  3. Verify readiness to implement robust fallback language for derivatives based on ISDA’s Benchmark Supplement (EU BMR) and IBOR fallback amendment to the 2006 ISDA Definitions (expected Q4 2019)
  4. Identify all impacted contracts, develop an inventory of those referencing IBORs, and consolidate impacted contracts to one or more contract repositories for analysis, remediation and repapering (if needed)
  5. Source a representative sample of contracts referencing IBORs and assess the strength of fallback language in legacy transactions by contract type, product and client segment – assessment should help prioritize remediation efforts
  6. Assess potential financial, legal and conduct risk due to permanent cessation of IBORs, including non-adherence to the ISDA protocol by specific client segments and the impact of differences in fallback language between cash and derivatives
  7. Assess the feasibility of leveraging technology solutions to digitize and extract fallback language for all legacy transactions referencing IBORs, thus reducing manual effort up to 75%
  8. Define a legal remediation, product transition and client outreach and communication strategy based on fallback language and consent provisions, product type and client segment for all legacy transactions maturing post-2021
  9. Systemically extract and store fallback language at the point of inception (new client or contract) for all new transactions in a legal data repository
  10. Identify impacted systems (internal and third-party) and develop detailed business requirements for system updates to operationalize fallback language in the event of an IBOR cessation
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    1. The number of contracts referencing LIBOR that are likely to be impacted is significantly higher for firms with significant exposure to LIBOR in consumer and commercial lending, corporate trust, and asset servicing activities. In addition, in some instances firms cannot identify which contracts have references to LIBOR without assessing the entirety of their contract population; this is primarily a result of unclear metadata associated with each contract.


The unprecedented scale of changing from IBOR to ARR cannot be underestimated and poses considerable challenges for the industry. To achieve a smooth IBOR transition, firms will need to manage legal and contractual issues, fallback language and their strategy for new products and legacy transactions. 

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By EY Global

Ernst & Young Global Ltd.