Welcome to KPMG’s latest issue of our monthly LIBOR newsletter in which we provide updates on LIBOR and other benchmark interest rate developments that directly impact banks and consider the potential implications of the related regulatory requirements.
1. MAS Sets Up Steering Committee to Drive the Interest Rate Benchmark Transition from SGD Swap Offer Rate (SOR) to Singapore Overnight Rate Average (SORA)
The Monetary Authority of Singapore (MAS) announced the establishment of the Steering Committee for SOR Transition to SORA (SC-STS). The committee will be responsible for providing strategic direction on industry proposals to develop new products and markets based on SORA. The SC-STS will also engage with stakeholders to seek feedback and raise awareness on issues related to the transition from SOR to SORA. SORA has been published since 2005 and is based on transactions in a deep and liquid overnight funding market.
KPMG Insight: The calculation of SOR has a dependency on USD LIBOR, therefore we expect the MAS will accelerate the transition from SOR to SORA even before LIBOR ceases after the end of 2021. In addition to monitoring LIBOR exposures, financial institutions should also include SOR exposures in their exposure quantification and stay tuned to further guidance from MAS on the fallback provisions and adjustments.
30 August 2019 MAS
2. CFTC Market Risk Advisory Committee Approves Plain English Disclosures at Public Meeting
The U.S. Commodity Futures Trading Commission’s Market Risk Advisory Committee (MRAC) approved plain English disclosures for new derivatives referencing the London Interbank Offered Rate (LIBOR) and other IBORs which market participants could use, as they deem appropriate, with all clients and counterparties with whom they continue to transact derivatives referencing LIBOR and other IBORs to inform them about the implications of using such products. The users can select the appropriate disclosures based on: (1) whether they are entering a transaction based on LIBOR or a different IBOR, and (2) whether they are entering the transaction prior to, or after, implementation of the new fallback in 2006 ISDA Definitions.
KPMG Insight: Financial institutions should consider incorporating the disclosure examples and making reference to any existing disclosure information to customers. This can effectively mitigate conduct risk in the LIBOR transition process, which is a growing focus of regulators around the globe.
9 September 2019 CFTC MRAC
3. U.S. Prudential Regulators Propose to Adopt Relief for Margin Exchange Requirements for Contract Amendments due to IBOR Transition
The U.S. Prudential Regulators published a proposal adopting relief for regulations that require swap dealers and security-based swap dealers to exchange margin with their counterparties for swaps that are non-centrally cleared. The proposed rule would permit legacy swaps to retain their legacy status in the event that they are amended to replace an IBOR or other discontinued rate.
KPMG Insight: The update echoes the joint statement issued by the BCBS and IOSCO on 5 March 2019, followed by a circular titled “Updates on SPM module CR-G-14” issued by the HKMA on 18 March 2019. In Hong Kong, the HKMA clarifies that amendments to legacy derivative contracts pursued solely for the purpose of addressing interest rate benchmark reforms do not require the application of the margin requirements.
17 September 2019 FDIC
4. President of New York Fed Urges Speedier Transition Away from LIBOR
In remarks at the fifth annual U.S. Treasury Market Conference, New York Fed President John Williams highlighted the urgent need to transition away from LIBOR. Per Williams, “There’s no one-size-fits-all approach for closing out or converting existing LIBOR positions so market participants need to get ahead of this issue… If your firm is one of those hoping the problem will go away, or feeling nostalgic and counting on an extension to the deadline, take this message back: The clock is ticking, LIBOR’s days are numbered.”
KPMG Insight: Considering the significant size of LIBOR-referenced market and wide-spread impact of LIBOR transition, financial institutions should start establishing project plan for LIBOR transition which may include setting up governance framework, conducting impact assessment, developing detailed transition plan and communication strategy, etc.
23 September 2019 FRBofNY
5. EMEAP Publishes Report "Study on the Implications of Financial Benchmark Reforms"
The Working Group on Financial Markets (WGFM) of the Executives’ Meeting of East Asia-Pacific Central Banks (EMEAP), where the HKMA is a member, published a report titled “Study on the Implications of Financial Benchmark Reforms”. The report provides a brief overview of the three areas of financial benchmark reforms (LIBOR discontinuation, EU benchmark regulation, and local benchmark reforms), summarises the results of WGFM survey and the discussion among EMEAP members and private financial institutions, as well as identifying risk scenarios and proposing some policy recommendations for EMEAP members’ consideration.
KPMG Insight: The report reiterates Asian banking regulators’ key focuses on the benchmark reforms. The members agree to take further actions in requesting financial institutions to develop a robust governance framework and impact analysis on the LIBOR-related exposures. This is consistent with our view that financial institutions should start forming their governance framework, assessing risks and different transition scenarios, and quantifying LIBOR exposures in the next three to six months.
24 September 2019 EMEAP
6. FHFA Instructs FHLBanks to Begin Transitioning Away from LIBOR
The Federal Housing Finance Agency sent a letter to the 11 Federal Home Loan Banks instructing them to stop purchasing investments in assets tied to LIBOR with a contractual maturity beyond 31 December 2021 by 31 December 2019.
27 September 2019 FHFA
1. FASB Proposes Guidance to Assist in Transition Away from Interbank Offered Rates to New Reference Rates
The Financial Accounting Standards Board (FASB) issued a proposed Accounting Standards Update (ASU) that would provide temporary optional guidance to ease the potential burden of accounting for, or recognizing the effects of, reference rate reform on financial reporting. The proposed ASU will apply only to contracts or hedging relationships that reference LIBOR or another reference rate expected to be discontinued due to reference rate reform, i.e. the proposed amendments would not apply to contract modifications made, and hedging relationships entered into, or evaluated after December 31, 2022.
KPMG Insight: The proposed guidance primarily provides relief to financial institutions which adopt hedge accounting under IAS 39 or IFRS 9. The relief can reduce financial institutions’ concern in a de-hedge situation which could result in significant P&L impact.
5 September 2019 FASB
2. ARRC Releases Meeting Minutes from September Meeting
The Alternative Reference Rates Committee (ARRC) released minutes from its September meeting, which included a presentation providing preliminary analyses on potential spread adjustment methodologies for cash products for the ARRC’s consideration. The minutes also include a presentation on the parameters being considered by the Federal Reserve Bank of New York for its production of SOFR averages and a related index, currently planned to commence in the first half of 2020.
KPMG Insight: The preliminary analysis of potential spread adjustment methodologies attached to the meeting minutes provides useful insights to financial institutions which have outstanding cash product contracts referencing LIBOR that expire after the end of 2021. It includes discussions on the different methodologies when financial institutions insert the new fallback clauses into the existing contracts and the determination of spread adjustment. Financial institutions should keep track of the development on potential spread adjustment methodologies and consider the financial and operational implications.
10 September 2019 ARRC
3. CME SOFR Futures Became a Trillion-dollar Market
On September 17, CME Group announced that CME SOFR futures became a trillion-dollar market. Record single-day volume of US$670 billion was traded with US$1.17 trillion in open interest, in response to the upward pressure in the repo market.
17 September 2019 CME Group
4. ISDA Publishes Consultation on Final Parameters for Benchmark Fallback Adjustments
The International Swaps and Derivatives Association (ISDA) launched a new consultation to finalize the methodologies – (1) historical mean/median approach to the spread adjustment, and (2) compounded setting in arrears – for the adjustments that will be made to derivatives fallbacks in the event certain interbank offered rates (IBORs) are permanently discontinued. The new consultation will close on 23 October, with both the amended definitions and the protocol expected to be finalized by the end of this year, and implemented in 2020.
KPMG Insight: Many financial institutions in Hong Kong are currently hesitant to take a proactive approach to amend the existing contracts referencing LIBOR due to the uncertainty in some of the technical details when transitioning from LIBOR to the new RFRs. The ISDA consultation provides some guidance on two of the most common uncertainties: (1) what the spreadsheet adjustment would be to minimise day one P&L; and (2) how interest would be calculated without an RFR term structure.
18 September 2019 ISDA
5. ARRC Updated the SOFR Frequently Asked Questions
The ARRC updated its Frequently Asked Questions document to include further information regarding questions about volatility in SOFR (Question 16). The response explains that contracts referencing SOFR have been based on averages of the daily rates, which have been quite smooth and can be easily referenced in financial contracts.
19 September 2019 ARRC
6. ARRC Releases Practical Implementation Checklist for SOFR Adoption
The Alternative Reference Rates Committee (ARRC) released a checklist outlining 10 key areas, with specific emphasis on governance, communications, risk management, and operational readiness, to help market participants design a robust transition plan. The checklist is not a strict plan and does not deliberately include timeline, but expounds on practical considerations that should be taken into account in developing a paced transition plan.
KPMG Insight: The ARRC checklist provides a list of practical action items for each focus area in the transition. The nine focus areas is consistent with KPMG’s suggested approach to implement an effective and smooth transition. Financial institutions should consider to supplement the action items into their transition plan.
19 September 2019 ARRC
7. The LMA Publishes Exposure Drafts of Compounded Risk-free Rate Facility Agreements for Sterling and US Dollars
The LMA announces the publication of exposure drafts for: (1) a compounded SONIA-based sterling term and a revolving facilities agreement; and (2) a compounded SOFR-based dollar term and revolving facilities agreement.
KPMG Insight: The release of the exposure draft can be seen as an initiative to encourage financial institutions to start writing loans referenced to new RFRs (e.g. SONIA and SOFR). Financial institutions which have plans to start pricing their term and revolving facilities using new RFRs when the exposure drafts are finalised.
23 September 2019 LMA
8. IASB Finalises Phase 1 of its IBOR Reform Project
The International Accounting Standards Board (IASB) published the “Interest Rate Benchmark Reform (Amendments to IFRS 9, IAS 39 and IFRS 7)”. The amendments are designed to provide guidance to companies during the period of uncertainty arising from the LIBOR phase-out. The amendments are expected to come into effect from 1 January 2020, but companies may choose to apply them earlier.
KPMG Insight: Similar to the FASB proposed guidelines described above, the IASB guidance provides additional information for pre-LIBOR cessation accounting issues in respect of hedge accounting.
26 September 2019 IASB
Partner, Head of Financial
Financial Risk Management
Partner, Financial Risk Management
Financial Risk Management