Interbank Offered Rate (IBOR) Reforms


LIBOR Transition and IBOR Reforms

Overview(1)
Interest rate benchmarks including the London Interbank Offered Rate (LIBOR), the Euro Interbank Offered Rate (EURIBOR), the Euro Overnight Index Average (EONIA) and certain other Interbank Offered Rates (IBORs) are being reformed.

These reforms are expected to cause at least some IBORs to perform differently to the way they do currently or to disappear, which may impact the Hang Seng products and services you currently use and those we provide in the future.

Regulatory authorities and public and private sector working groups in several jurisdictions have been discussing the alternatives to IBORs but there is still uncertainty over when these alternative rates will be available and how the reforms will impact specific financial products and services.

The content of this page reflects Hang Seng’s current understanding and does not constitute any form of advice or recommendation. Clients should consider if they require guidance from their professional advisors on the possible implications of the changes including from a financial, legal, accountancy or tax perspective.

Background
In financial products such as derivatives, bonds, loans, structured products and mortgages, interest rates can be fixed or alternatively calculated by reference to benchmark rates.

LIBOR, probably the most widely used benchmark, covers financial products denominated in GBP (British Pound), USD (US Dollar), EUR (Euro), JPY (Japanese Yen) and CHF (Swiss Franc). Certain currencies are also covered by their local benchmark such as EURIBOR and EONIA for EUR or the Tokyo Interbank Offered Rate (TIBOR) for JPY.

Financial regulatory authorities have expressed their concern that the interbank lending market, which IBORs are intended to reflect, is no longer sufficiently active or liquid. This concern has resulted in an effort to encourage financial markets to transition from the use of IBORs to risk free rates (RFRs) or change the way that IBORs are currently determined.

What alternative benchmarks may replace the current IBORs?
Public and private sector RFR working groups, including in the EU, US, UK, Switzerland and Japan, have identified alternative risk-free rates, as shown in the table below, and have begun developing strategies for transition:

Currency Reference Rate Anticipated replacement Regulator
USD USD LIBOR2 SOFR (Secured Overnight Financing Rate) Federal Reserve Bank of New York
EUR EURIBOR To be confirmed. Alternatives might include a reformed EURIBOR or ESTER (Euro Short Term Rate) European Central Bank
EUR EONIA (EUR) ESTER (Euro Short Term Rate) European Central Bank
GBP GBP LIBOR Reformed SONIA (Sterling Overnight Index Average) Bank of England
CHF CHF LIBOR SARON (Swiss Average Rate Overnight) Swiss National Bank
JPY JPY LIBOR & IBOR (JPY) TONAR (Tokyo Overnight Average Rate) Bank of Japan

 

What do we know about these alternative benchmarks?
The RFRs under consideration are overnight near risk free rates while the IBOR rates incorporate both a term structure and bank credit risk.

A number of working groups are considering methodologies for supporting a term structure for the alternative RFRs. The term structure for Reformed SONIA is expected to be defined by mid-2019. The Alternative Reference Rates Committee (ARRC) in the US is also looking at developing the term structure for SOFR during the course of 2019. We anticipate term structures will evolve for each RFR as liquidity increases in the market.

LIBOR and most other IBORs are intended to measure unsecured interbank lending rates, whereas the proposed RFRs are based on short-term wholesale transactions for unsecured RFRs (i.e. SONIA and TONAR) and repo transactions for secured RFRs (i.e. SOFR and SARON). As a result, IBORs include or imply a credit spread over the RFRs. Spread adjustment may consequently be required when transitioning from IBORs to RFRs.

The new reference rates will be administered by the central bank (or nominated independent body) in the relevant jurisdiction. The Federal Reserve Bank of New York (FRBNY) for instance began publishing SOFR in April 2018 on a daily basis.

When will the changes take effect?
This depends on the relevant IBOR. For example, the UK Financial Conduct Authority (FCA) has stated that after 2021 it will no longer compel banks to submit rates used for the calculation of LIBOR and that firms should treat the discontinuation of LIBOR as something that will happen.

The RFRs for USD, GBP, CHF, and JPY are already published alongside the relevant IBORs. Certain market participants have started issuing bonds referencing the RFRs.

For existing transactions that extend beyond 2021, market participants may have to decide whether to convert them to the new benchmarks or use fall-back rates once the existing IBOR is discontinued. There are industry efforts to standardise the approach.

What do these reforms mean for Hang Seng clients?
These changes may impact the Hang Seng products and services you currently use and those we provide in the future, including changes to interest payment and other obligations. The extent of the impact will depend on a range of factors such as the IBOR referenced, the adjustment defined by the industry working groups, the date by when the changes will take effect and the nature of the product or service.

For example, if there is a permanent discontinuation of LIBOR and an alternative benchmark is agreed for a loan facility, it is possible that the alternative benchmark may result in changes to the amount payable under the facility.

We are actively monitoring developments. Hang Seng will provide more detailed information to impacted clients once there is more certainty on which new benchmarks are being adopted, their methodology, their term structure and the transition process agreed at industry level.

For more information
We will periodically update this site and/or provide communications relating to the reforms. In the meantime, if you require any further information, please contact your usual Relationship Manager.

The Frequently Asked Questions below attempt to clarify some of the key themes surrounding the reforms to interest rate benchmarks.

If you would like more general information on interest rate reform and IBOR transition, the FCA, the Bank of England, the U.S. Commodity Futures and Trading Commission, the FRBNY, the European Central Bank, the Financial Stability Board, the International Organization of Securities Commissions and some of the working groups/industry bodies that are considering these issues have published information which can be found on their websites.

1 This summary provides an overview of the expected changes as at today, albeit there is significant uncertainty. We expect further regulatory guidance will be provided at national or supranational levels over the coming months.

2 The ARRC anticipates SOFR replacing the Effective Federal Funds Rate (EFFR) as the rate used for discounting and Price Alignment Interest (PAI) in the cleared context beginning Q1 2020.