Interbank Offered Rate (IBOR) Reforms


LIBOR Transition and IBOR Reforms

Overview(1)

Interest rate benchmarks including, among others, 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.

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. This means that LIBOR is expected to be discontinued, most likely after the end of 2021. Regulators globally have emphasised that it is now time for market participants to start transitioning from the use of IBORs to alternative benchmark rates.

Regulatory authorities and public and private sector working groups in several jurisdictions, including the International Swaps and Derivatives Association (ISDA), the Sterling Risk-Free Rates Working Group, the Working Group on Euro Risk-Free Rates, and the Alternative Reference Rates Committee (ARRC), have been discussing alternative benchmark rates to replace the IBORs. These working groups are also considering how to support a transition to alternative rates and the development of new products referencing them.

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

The content of this page reflects Hang Seng’s current understanding of the expected changes as at July 2019. Considering the current level of uncertainty, this overview is not complete or exhaustive and does not constitute any form of advice or recommendation. Clients should contact their professional advisors on the possible implications of the changes such as financial, legal, accountancy or tax consequences.

Background

A wide range of financial products such as derivatives, bonds, loans, structured products and mortgages, use benchmark rates to determine interest rates and payment obligations. Benchmark rates are also used to value certain financial products and as a performance tracker for funds, among other purposes.

LIBOR, probably the most widely used benchmark, is used in financial products denominated in a number of currencies and is published in GBP (British Pound), USD (US Dollar), EUR (Euro), JPY (Japanese Yen) and CHF (Swiss Franc).

Certain currencies also use specific benchmarks such as EURIBOR and EONIA for EUR, the Tokyo Interbank Offered Rate (TIBOR) for JPY, the Hong Kong Interbank Offered Rate (HIBOR) for Hong Kong Dollar and the Singapore Interbank Offered Rate (SIBOR) for Singapore Dollar.

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 recommendations made by the Financial Stability Board (FSB) in 2014 to reform major interest rate benchmarks and use near risk-free rates (RFRs) that are based on more active and liquid overnight lending markets, instead of IBORs where appropriate.

What are the replacement benchmarks and which benchmarks are changing?

RFR working groups in several jurisdictions have identified replacement benchmarks and have begun developing strategies for transition. Select examples of benchmarks which are either being replaced or benchmarks where changes either have or will be made to their methodology (notably the way in which they are determined) are set out in the table below.

Currency Current rate
Alternate Rate
Anticipated Approach
AUD
BBSW(1)
BBSW (Bank Bill Swap Rate)’s new methodology became effective on 21 May 2018.
The Cash Rate, also referred to as AONIA, is a pre-existing rate that will become the RFR for AUD.
Multiple rate approach.
The reformed BBSW is expected to continue alongside 
CHF
CHF LIBOR
SARON (Swiss Average Rate Overnight) is a pre-existing rate that was recommended as the alternative to CHF LIBOR in October 2017.
Transition to SARON.
EUR EONIA
€STR (Euro Short-Term Rate) will be published from 2 October 2019(1).
Transition to €STR.
EONIA will continue to exist under a new methodology from 2 October 2019 to allow a smooth transition to €STR and is currently expected to be discontinued on 3 January 2022. 
EUR
EURIBOR or EUR LIBOR
Reforms to EURIBOR are expected to be completed by the end of 2019.
As above, €STR, the RFR for EUR, will be published from 2 October 2019.
Multiple rate approach.
The reformed EURIBOR is currently expected to continue alongside €STR.
As with other LIBORs, EUR LIBOR is expected to be discontinued (probably sometime after 2021). In respect of EUR LIBOR, market participants are expected to transition to €STR.
GBP
GPB LIBOR
SONIA (Sterling Overnight Index Average) was subject to a number of reforms and these were implemented from 23 April 2018.
Transition to SONIA. 
HKD
HIBOR
HONIA (Hong Kong Overnight Index Average), the RFR for HKD, is a pre-existing rate. Reforms to HONIA are currently being considered.
HIBOR (Hong Kong Interbank Offered Rate) has been subject to a number of reforms and may be further reformed in the future. 
Multiple rate approach.
HIBOR is expected to continue alongside HONIA.
JPY
JPY LIBOR and TIBOR (Japanese Yen TIBOR and Euroyen TIBOR)
TONAR (Tokyo Overnight Average Rate), the RFR for JPY also called TONA, is a pre-existing rate.
TIBOR (Tokyo Interbank Offered Rate) is being reformed. 
Multiple rate approach.
JPY TIBOR is expected to continue alongside TONAR It is possible that Euroyen TIBOR will be discontinued.
SGD
SIBOR and SOR
The Singapore Foreign Exchange Market Committee continues to consider alternative risk-free rates for SGD (Singapore Dollar). SIBOR (Singapore Interbank Offered Rate) has been subject to a number of reforms and is expected to undergo further reforms around end 2019 or early 2020.
SOR (Swap Offer Rate) is being reviewed (it is calculated by reference to USD LIBOR). 
Multiple rate approach.
Reformed SIBOR is expected to continue alongside (potentially an adjusted version of) SOR.  
USD
USD LIBOR
SOFR (Secured Overnight Financing Rate)(2)has been published since April 2018. Transition to SOFR. 

The table above is not exhaustive. There may be other benchmarks which are either discontinued or where changes have or will be made to their methodology.

What do we know about these alternative benchmarks?

IBORs are “term rates”, which means they are published for different periods of time such as 3 months and 6 months and are “forward looking”, which means they are published at the beginning of the borrowing period.

Most alternate benchmarks are “backward-looking” overnight rates based on actual historic transactions. They are published at the end of the overnight borrowing period.

The RFRs under consideration are overnight near risk free rates while IBORs incorporate both a term structure and bank credit risk.

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, TONA and €STR) and repurchase or “repo” transactions for secured RFRs (i.e. SOFR and SARON). As a result, IBORs include or imply a credit spread over the RFRs.

To transition existing contracts and agreements that reference IBORs to the alternative benchmark rates, adjustments for credit and term differences may need to be incorporated and applied to the alternate rate.

Industry working groups are reviewing methodologies for calculating these adjustments and are considering whether robust forward-looking term versions of the RFRs can be developed. The Working Group on Sterling Risk-Free Reference Rates, for example, anticipates that a term SONIA reference rate could be developed in the first quarter of 2020. In the United States, the Alternative Reference Rates Committee (ARRC) is looking at creating a term SOFR rate by the end of 2021.

However, Andrew Bailey, chief executive officer of the Financial Conduct Authority said at a conference held on 15 July 2019 that although a “forward-looking term version of SONIA should be useful to some niche users in cash markets, […] the use of these forward-looking term rates is meant to be limited. These term rates cannot and will not be the primary avenue to transition. The risk-free rates themselves, SONIA and SOFR, should serve that purpose.”

When will the changes take effect?

Depending on the IBOR, changes are likely to be made to different products and in different jurisdictions or regions at different times.

For example, RFRs for USD, GBP, CHF, and JPY are already published alongside the relevant IBORs. €STR, the RFR for EUR is expected to be published from 2 October 2019. Certain market participants have started issuing bonds referencing RFRs

For existing transactions that extend beyond 2021, market participants may have to decide whether to replace the referenced IBOR with the alternative benchmark ahead of the discontinuation of the IBOR or to use so-called “fallback” provisions(3) that will determine the replacement of the referenced IBOR with the alternative benchmark only once the IBOR is discontinued.

There are industry efforts to standardise the approach, although fallbacks may include different provisions across products such as different trigger events, timings or even a different fallback rate.

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. The extent of the impact will depend on a range of factors including the following:

  • • which IBOR is referenced;
  • • the nature of the “fallback” provisions, where the product includes such provisions (for example, the ISDA Benchmarks Supplement may be incorporated in your derivatives transactions);
  • • the adjustment for credit and term differences (i.e. between the IBOR and the alternative risk-free rate) defined by industry working groups;
  • • the term of the product or contract;
  • • the date when the changes will take effect; and
  • • the nature of the product. 
  •  

The reforms could have a number of impacts on clients. These impacts include possible changes to contractual documentation, adaption of operational processes/IT systems, changes to the value of products or the possibility of products no longer serving the purpose for which they were intended. . Depending on the factors listed above, by way of example, the discontinuation of an IBOR referenced in a loan facility and its replacement by an agreed alternative benchmark may also result in changes to the amount payable under the facility.

The impact of the changes may also vary depending on whether the relevant benchmark is being discontinued or if it is being reformed. For example, in the case of any transaction referencing EURIBOR, the European Money Markets Institute (the administrator of EURIBOR) is changing the way in which it determines EURIBOR. This change could result in EURIBOR being higher or lower than would be the case if it were to be determined using the previous methodology.

We are actively monitoring developments and participating in a number of industry and regulatory working groups. Hang Seng will continue to provide more information on the changes, notably when there is more certainty on which new benchmarks are being adopted, their methodology, their term structure and the transition process agreed at industry level.

The changes may impact products and services in a number of ways and the information provided on this page cannot be, and is not, exhaustive. You should contact your professional advisors on the possible impact of the IBOR reforms on the financial products and services you use or may use in the future.


For more information

We will periodically update this site and provide communications relating to the changes. In the meantime, if you require any further information, please contact your usual Relationship Manager. Hang Seng may also provide you with product or service specific information which you should consider carefully. The Frequently Asked Questions below attempt to clarify some of the key IBOR reform themes.

If you would like more general information on interest rate reform and IBOR transition, the Financial Conduct Authority (FCA), the Bank of England, the U.S. Commodity Futures and Trading Commission (CFTC), the Federal Reserve Bank of New York (FRBNY), the U.S. Alternative Reference Rates Committee (ARRC), the European Central Bank (ECB), the Financial Stability Board (FSB), the International Organization of Securities Commissions (IOSCO) and some of the working groups and industry bodies that are considering these issues have published information which can be found on their websites.

1 The rate published on 2 October 2019 will be the rate for 1 October 2019 as €STR will be published on a next-day basis.

2 The ARRC (Alternative Reference Rates Committee) 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.

3 A “fallback” provision sets out the consequences of an event. For example, it may provide that the parties should use an alternative rate as and when an IBOR is permanently discontinued.