February 15, 2021
In Asia-Pacific and around the world, financial institutions are grappling with the transition to new reference rates. The referencing of IBORs in many financial contracts means that managing transition risk is crucial. And as regulators consult with the industry, shifting deadlines and differing liquidity profiles for the new rates are adding to complexity.
ICE Benchmark Administration (IBA) which compiles and oversees LIBOR, has consulted on its intention to cease publication of one-week and two-month US dollar LIBOR and all tenor settings of EUR, GBP, CHF and JPY LIBOR at the end of 2021, and to cease the more widely used US dollar LIBOR benchmarks at the end of June 30, 2023. In the case of the US dollar benchmarks, this followed the announcements of the US official sector to allow an extension for outstanding legacy contracts that mature by this date. In its place, the Secured Overnight Financing Rate (SOFR) has been recommended as a replacement by the Alternative Reference Rates Committee.
The SOFR index is based on the US Treasury Repo cash market and has robust liquidity, with transactions that average ~$1 trillion per day in notional value. Its use is growing gradually compared to the USD LIBOR index it will replace. Yet a recent supervisory note from some US regulators indicated banks should have no new usage of LIBOR in any product by the end of 2021 - an announcement which should accelerate the transition.
ICE is a key global player in supporting market participants in the move to alternative reference rates, with heavy involvement in transitions such as LIBOR-SOFR and LIBOR-SONIA (the Sterling Overnight Index Average).
Importantly, ICE products and services can help market participants manage the transition of IBOR-based futures and options positions with market-based solutions such as Inter-Contract Spreads and Asset Allocation. This means they can better manage their transition from IBOR to the respective risk free rate.
To help clients manage risk in their derivative portfolios, ICE offers analytics that cover the impact of IBOR fallback for existing structures. Market participants can view valuations of their positions based on the compounded and spread fallback projections after the transition date, under different scenarios for that date. This feature in USD, EUR, JPY, AUD, SGD, GBP, CHF and other markets, helps clients understand the impact of a fallback on the valuation of their positions.
Quality, compliance and reliability are central to ICE’s market data, and further reflected in its operation of several exchanges including the New York Stock Exchange, and six clearing houses.
In Asia-Pacific, countries fall under three broad categories on benchmark transition. Firstly, those moving to a new Risk Free Rate (RFR) with complete cessation of the existing benchmarks. Here, Singapore and Thailand are examples - with both working to build liquidity of the RFR, and central banks issuing or planning to issue floating-rate notes that reference the new rate. These countries also create a temporary fallback rate for existing contracts that fail to switch after the deadline, despite best efforts.
Secondly, countries such as Japan, Australia, New Zealand and Hong Kong are taking a dual approach - where a new RFR has been identified but use of existing benchmarks will be permitted. These nations will be challenged to nurture liquidity in new RFRs. Already, regulators have moved to boost debt issuance linked to the new RFRs - with suggestions that the range of participants in markets using instruments referencing the RFRs should be broadened. Elsewhere, countries such as South Korea and India remain undecided on their approach to benchmark reform. Across the region, consultations demonstrate varying stages of transition but highlight common issues - such as fallback methodologies and cessation timelines.
Japan stands out as APAC’s major interest rate swap market at over $40 trillion in size, with the bulk linked to JPY LIBOR, which is administered by IBA. Following a consultation on alternative benchmarks to JPY LIBOR, industry preference pointed to two alternatives: the long existing Tokyo Interbank Offered Rate (TIBOR) and the newly identified Tokyo Overnight Average Rate (TONAR) a risk-free rate based on the uncollateralized overnight call rate. TIBOR is a benchmark that reflects local market conditions, where Japan looked to create a forward looking rate due to the persistent negative interest rate environment. This is a contrast to the general trend of backward looking RFRs. QUICK Corp has been appointed the calculation and publication agent for a term reference rate, the Tokyo Term Risk Free Rate (TORF) and expects to start publishing production rates for use in transactions no later than mid-2021.
While many APAC participants have taken a wait-and-see approach to the transition, shifting timelines and differing liquidity profiles for the new rates underscores the need for preparedness. With a depth of expertise in markets and risk management, ICE can help global clients adapt to the new regime - enabling them to stay ahead of compliance mandates, and keep their competitive edge.
As European participants assess the consequence of benchmark reform for their portfolios and balance sheets, any new contracts will need close assessment. Germany is poised to play an increasingly vital role in European financial markets after Brexit, and faces particularly high impact in terms of country risk.
We can help you manage the shift, with real-time derivatives data, valuations and analytics, futures contracts on all major alternative rates and ICE Benchmark Administration’s preliminary Term Rates for SONIA.