The Constant Maturity Swap Rate, also known as the CMS rate, ISDAFIX or the ICE Swap Rate, represents the mid-market fixed rate for fixed/floating interest rate swaps for a set of tenors at a specified time of day. For the USD CMS Rate, the floating rate leg references three-month USD LIBOR.1 That, in a nutshell, will be a problem after June 30, 2023, when three-month USD LIBOR will cease publication.

The USD CMS Rate is often referenced in structured notes, usually as the difference between two tenors, such as 30Y CMS - 5Y CMS. What will happen to the USD CMS Rate after June 30, 2023?2 There are two approaches that have been put forth.

In March 2021, the Alternative Reference Rates Committee ("ARRC") published a white paper discussing a suggested fallback formula for the USD CMS Rate. 3 The fallback formula is designed to be built into USD CMS Rate instruments (such as floating rate notes, although the white paper focuses on derivatives) so that, upon the cessation of the USD CMS Rate, the instrument will continue to function properly, but the floating rate will be calculated based upon an expected SOFR CMS Rate as adjusted by the fallback formula.

For a floating rate note, the terms would have to be drafted so that the fallback formula would take effect after a cessation of the USD CMS Rate, or the USD CMS Rate becoming non-representative. The terms could be modeled after the USD LIBOR to SOFR recommended fallback language published by the ARRC. Of course, this suggested fallback formula is not helpful for any existing USD CMS Rate floating rate notes. In any event, the fallback formula cannot be used until the SOFR CMS Rate, computed at the same time, with the same day count convention and the same payment frequency as the USD CMS Rate, exists.

Another option is for ICE to cease publication of the USD CMS Rate after June 30, 2023. In May 2021, ICE published a consultation on the potential cessation of the GBP LIBOR CMS Rate.4 The floating rate leg of the GBP LIBOR CMS Rate is GBP LIBOR, which will cease publication on December 31, 2021. According to the IBA, it "does not expect to be able to continue to publish GBP LIBOR ICE Swap Rate settings for which the 3 Month or 6 Month GBP LIBOR settings serve as the underlying rate for the floating leg of the relevant interest rate swaps after December 31, 2021, because IBA does not expect sufficient (or perhaps any) input data to be available based on eligible new interest rate swap transactions referencing GBP LIBOR settings from this time." There is some discussion on the IBA website about using potential synthetic, unrepresentative GBP LIBOR settings to continue the publication of the GBP LIBOR CMS Rate.

IBA noted that it expects to consult on the potential cessation of the USD LIBOR CMS Rate "in due course." Similar to the GBP LIBOR CMS Rate, the IBA pointed to the possibility of a potential synthetic USD LIBOR for use in the USD CMS Rate. The IBA also stated that the consultation is "not ... an announcement that IBA will cease or continue the publication of . any other ICE Swap Rate settings, after December 31, 2021 or any other date."5

All of this should serve as a warning to issuers of USD CMS Rate floating rate notes to have clear fallback language built into their notes if and when the USD CMS Rate ceases publication. This fallback language could anticipate a replacement of the USD LIBOR floating rate leg while the USD CMS Rate continues to be published, or a cessation of the USD CMS Rate and its replacement with another industry accepted or governmental body recommended rate.

Originally published in REVERSEinquiries: Volume 4, Issue 4.
Click here to read the articles in this latest edition.

Footnotes

1. The CMS Rate is also published based on GBP LIBOR and EURIBOR.

2. New York General Obligations Law Article 18-C does not apply to contracts or securities based on the USD CMS Rate.

3. The ARRC White Paper is available at: NewYorkFed.org, ARRC White Paper on Suggested Fallback Formula for the USD LIBOR ICE Swap Rate.

4. The ICE GPB CMS rate consultation (the "Consultation") is available at: ICE Swap Rate (theice.com).

5. See the Consultation at 4.

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