LIBOR Transition and IBOR Reforms
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.
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.
||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
||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.
||€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.
||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.
||SONIA (Sterling Overnight Index Average) was subject to a number of reforms and these were implemented from 23 April 2018.
||Transition to SONIA.
||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 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.
||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.
||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:
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.
Interest rates can be fixed or alternatively calculated by reference to benchmark rates. The London Interbank Offered Rate (LIBOR) is one of the most commonly used benchmarks for interest rates and is referenced in financial products such as derivatives, bonds, loans, structured products and mortgages. It often forms the basis on which interest payments under those products are calculated.
LIBOR is published on each London business day and is administered by ICE Benchmark Administration (IBA). It is based on quotations received from LIBOR panel banks, which are a group of banks who provide information to IBA as to the amount it would cost them to borrow from other banks so that an average can be calculated and published.
LIBOR is published in five currencies (euro, Japanese yen, pound sterling, Swiss franc and US dollar) and for seven interest periods (ranging from overnight to 12 months. 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.
The issues which affect the perceived robustness of LIBOR (such as the lack of interbank lending transactions on which to base the rate) also affect other interbank offered rates (IBORs) such as the Euro Interbank Offered Rate (EURIBOR).
In addition to IBORs, other interest rate benchmarks are being looked at. For example, the Euro Overnight Index Average (EONIA) will be using a new calculation methodology from 2 October 2019 before being replaced by €STR from 3 January 2022.
In the United States, the preferred risk-free rate (which is called the Secured Overnight Financing Rate or SOFR) is a new rate. Currently, the most frequently used overnight interest rate benchmark in the United States is the Effective Federal Funds Rate (EFFR). In connection with the transition away from US dollar LIBOR, a working group in the United States that consists of both private and public sector entities (the Alternative Reference Rates Committee or ARRC) is currently planning a transition to SOFR. This transition will result in SOFR being used instead of EFFR in a number of cases.
Other rates are also being looked at in, amongst other places, Hong Kong, Singapore, Switzerland, Japan, Australia and Canada.
Hang Seng, as a member of the HSBC Group is working closely with HSBC who is participating in a number of public and private sector working groups such as the Sterling Risk-Free Rate Working Group, the Alternative Reference Rates Committee in the United States and the Working Group on Euro Risk-Free Rates, each of which is responsible for identifying the preferred risk-free rate for the relevant currency and planning transition to that risk-free rate.
Hang Seng is aware that the discontinuation of LIBOR or other IBORs may impact both its new and existing products and services and that the impact on all parties, including clients, will need to be carefully considered.
Hang Seng is conducting due diligence to review and confirm how LIBOR and other IBORs are used in Hang Seng products or services. Hang Seng is monitoring this situation and, where required, will provide clients with further information.
While Hang Seng’s internal planning and due diligence on these changes has already started, as noted above, it is not yet possible to accurately determine the precise impact on all parties, including clients, until a replacement for the existing benchmark rates (including the preferred risk-free rate and any necessary adjustments) have been confirmed at industry level and until more information is known on the timing of the changes.
Hang Seng will continue to inform clients 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.
Although the impact of the reforms is still unclear, we expect most clients will assess how the affected interest rate benchmarks are used in their financial products and services. This will include an understanding of existing contracts and arrangements as well as the changes and risks that may arise from discontinuation or modification.
Clients should also 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.
Hong Kong Interbank Offered Rates (HIBOR) are the rates of interest for Hong Kong Dollar deposits for the relevant period calculated by HKAB each day (except Saturdays and general holidays) and displayed at 11:15 a.m. on the website of HKAB. The fixings are made on the basis of quotations provided by 12-20 banks designated by HKAB as reference banks and are available for HKD deposit maturity ranging between overnight deposits and 12 months. The fixings are determined by averaging the middle quotes after excluding the highest three quotes and lowest three quotes received from the reference banks.
According to Hong Kong Monetary Authority (HKMA), there is currently no plan to discontinue HIBOR in Hong Kong. However, Hong Kong is obliged to follow the recommendation of the Financial Stability Board (FSB) to identify an alternative reference rate (ARR) for HIBOR and the Treasury Markets Association (TMA) has proposed adopting the Hong Kong Dollar Overnight Index Average (HONIA) as the ARR. In other words, HONIA and HIBOR will co-exist in the market. Outstanding HIBOR-based loans will not be affected. However, should more HONIA-based products be introduced in the market, it would help reduce the market impact in case HIBOR has to be discontinued one day owing to changes in market circumstances.