Happy New Year! 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.

Regulatory Updates

1. SMR to apply to benchmark administrators

The UK Senior Manager Regime, which came into force in 2016 for banks, will now be extended to benchmark administrators that meet the 6 criteria for Enhanced Firms under the regime for FCA regulated firms, i.e. SMR will not apply to benchmark administrators that do not carry out any other regulated activities. The SMR will come into force for the in-scope benchmark administrators on 7 December 2020. The Treasury and the Financial Conduct Authority (FCA) believe that extending the SMR to this newly added category of authorised firms (introduced by the EU Benchmarks Regulation) will improve culture and governance within benchmark administrators. It will also strengthen market integrity by ensuring senior managers within benchmark administrators are accountable for their scope of activities and exercise oversight. Under the regime, benchmark administrators will be classified as ‘core’ firms as proposed by the FCA. However, they can use the FCA’s waiver process to apply for the ‘Limited Scope’ categorisation if appropriate.

KPMG Insight: Conduct and culture will continue to be the focus area for regulators worldwide and regulators will assess firms in these areas through broader thematic reviews. SMR will be less onerous for benchmark administrators than for other FCA authorised firms as there is some overlap with the BMR requirements such as, the application of the certification regime and allocation of senior management functions of money laundering reporting officer and compliance oversight.

29 November 2019 FCA


2. LIBOR in Swiss FINMA’s three- year risk radar

The Swiss Financial Market Supervisory Authority (FINMA) sees a disorderly abolition of LIBOR benchmark interest rates as one of the six principal risks for its supervised institutions and the Swiss Financial Centre. FINMA has highlighted three specific risk types in connection with the replacement of LIBOR interest rates: legal risk, valuation risk, and risks in connection with operational readiness. Analysis of FINMA-mandated self-assessments show that the majority of banks are still well behind schedule in their efforts to prepare for the replacement of LIBOR.

KPMG Insight: Banks in Asia Pacific (APAC) are also signalling lack of readiness towards IBOR transition and the survey respondents (from more than 20 large banks across APAC) cite lack of guidance from their central banks as the main reason of the delay. Detailed coverage can be found in the KPMG ASPAC LIBOR readiness report.

10 December 2019 FINMA


3. OCC Highlights Key Risks for Federal Banking System

The US Office of the Comptroller of the Currency (OCC) has reported to increase regulatory oversight amid LIBOR anticipated cessation to evaluate bank awareness and preparedness. Examiners will evaluate whether banks have begun to assess their exposure to LIBOR in assets and liabilities to determine potential impacts and develop risk management strategies.

KPMG Insight: The Hong Kong Monetary Authority (HKMA) is also in the process of gathering information, through a survey circulated to Authorised Institutions (AIs) at the end of 2019, on governance instituted by AIs to manage the transition, AIs transition plan and strategy, statistics related to outstanding and new contracts, and lastly whether new contracts contain adequate fallback provisions.

10 December 2019 OCC


4. CFTC’s Chairman delivers a word of caution on LIBOR continuity in 2022

In the speech on LIBOR transition at the Market Advisory Risk Committee meeting on December 11, 2019, the Chairman of the U.S. Commodities Futures Trading Commission (CFTC), Heath P. Tarbert reiterated that LIBOR will be sunsetting by the end of 2021 and any failure to transition away from LIBOR will pose risks to both the individual firm and the global financial system. Tarbert also highlighted the lurking threat of a “Zombie LIBOR” and the proposals being discussed on how to work in a period of non-representative LIBOR.

KPMG Insight: Firms should have already started to identify LIBOR impacted swap contracts and those which require fallback provisions to ensure smooth transition to SOFR with the support of the CFTC. CFTC is to facilitate conversion of US dollar LIBOR-based swaps to SOFR. This year is crucial for firms to transition away from LIBOR to relevant ARRs.

11 December 2019 CFTC


5. CFTC Provides Relief to Market Participants Transitioning Away from LIBOR

Three divisions of the U.S. Commodity Futures Trading Commission today announced that each has issued a no-action letter that outlines conditions under which counterparties will qualify for relief in connection with amending swaps to update provisions referencing LIBOR, or other interbank offered rates, to replacement rates. The relief provided by each division is explained in detail in the following letters: 19-2619-27 and 19-28.

KPMG Insight: Local or foreign financial institutions registered with the CFTC or which are exempt from registration with the CFTC must carefully distinguish swaps that are exempt under the no-action relief from those which need to trade (per the methods listed in § 37.9 for SEF-executed transactions) and require clearing (per the relevant sections of the Commodity Exchange Act (CEA)) to avoid any enforcement actions.

18 December 2019 CFTC


6. Letter from the PRA to the Working Group on Sterling Risk-Free Reference Rates

In the letter to the Working Group on Sterling Risk-Free Reference Rates (Working Group), Sam Woods, the Deputy Governor of the Prudential Regulatory Authority, tackled the Working Group’s comments pertaining to AT1 and Tier 2 Capital, Bilateral margin requirements for non-cleared derivatives, Rules related to Resolution and Counterparty Credit Risk, Market Risk, and Interest Rate Risk in the Banking Book. As the next steps, Woods indicated towards supervisory authorities regularly engaging with the major firms in 2020 and stressed the importance for banks’ senior management to remain closely engaged with the risks arising from the transition.

KPMG Insight: Firms should continue to engage in global and local RFR rates working groups and focus on building out their capabilities to support the transition from LIBOR through the development of new market structures and technologies.

18 December 2019 BOE

Industry Update

1. Cross-Industry Committee on JPY Interest Rate Benchmarks Publishes Results of its Consultation on the Appropriate Choice and Usage of JPY Interest Rate Benchmarks

The Cross-Industry Committee on JPY Interest Rate Benchmarks published the final report and results of its public consultation on the appropriate choice and usage of JPY interest rate benchmarks. In general, most respondents supported the use of term reference rates based on uncollateralised overnight call rate (TONA) but emphasised challenges in terms of the amount of time required to build liquidity in TONA to ensure its robustness and reliability.

KPMG Insight: Financial and non-financial institutions should align the conventions and approaches being developed across cash and derivative products (referencing different currencies), as for some products and currencies the use of overnight risk free rates may be a more suitable alternative than the term risk free rate (whereby, liquidity in the overnight indexed swaps, used to create a term rate, still remain thin or non-existent).

29 November 2019 Cross-Industry Committee


2. ISDA submits letter to FSB OSSG on pre-cessation issues

In addition to acknowledging the feedback provided by the Financial Stability Board Official Sector Steering Group (FSB OSSG) regarding addition of pre-cessation triggers as standard language, the International Swaps and Derivatives Association (ISDA) requested clarity from FSB OCCG on two other key points for market participants to understand the implications of a non-representative LIBOR – firstly, whether it is appropriate for a non-representative LIBOR to be published for more than a very minimal time period; and secondly, determining how CCPs would clear LIBOR derivatives once the FCA announces LIBOR to be non-representative.

KPMG Insight: Given that there are still quite a few moving parts, successful transition for the industry from LIBOR to the alternative risk-free rates relies on input from several individual working groups and bodies. Financial institutions should nevertheless have a schema by now with all available and pending inputs mapped out to avoid unidentified and unmitigated risks and losses at a later stage.

4 December 2019 ISDA


3. ARRC Chair Tom Wipf’s Opinion-Editorial on Transitioning to SOFR

In the Bloomberg opinion-editorial, authored by Tom Wipf, Alternative Reference Rates Committee (ARRC) Chair and Vice Chairman of Institutional Securities at Morgan Stanley, he endorses the use of SOFR and underscores market concerns regarding SOFR’s variability on the grounds that SOFR is averaged when used in financial instruments and that it will be endorsed by the New York Fed (publication of average SOFR by the New York Fed to commence in first half of 2020).

KPMG Insight: Firms to prepare responses to the New York Fed’s recent consultation paper on the publication of SOFR averages and a SOFR index. The feedback response period had been extended until 10 January2020. 

6 December 2019 ARRC


4. HK TMA Publishes Consultation Conclusion on Technical Refinements to HONIA

The Hong Kong Treasury Markets Association (TMA) announced conclusions on the following three technical refinements to the HKD Overnight Index Average (HONIA): data source, reporting window, and publication time. While the TMA will continue to undertake further study regarding enhancing representativeness of HONIA and extension of reporting window, it has been asserted that HONIA will continue to be published on a same day-basis in order to facilitate the use of HONIA for discounting and price alignment interest (PAI) calculation by the central clearing counterparties and market participants. The full text of the consultation conclusion can be found here.

KPMG Insight: Market participants should continue implementation of HONIA based on the conclusions set out in the consultation paper by the TMA. In the responses provided, the TMA has stated it will monitor and conduct further study in some of the areas such as data source and reporting window.

13 December 2019 TMA


5. Interest rate benchmarks in FSB’s 2020 work programme

As part of its work programme for 2020, the Financial Stability Board (FSB) will take stock of the implementation of benchmark reforms and report on remaining challenges to benchmark transition to improve understanding and increase awareness of the importance of ensuring timely transition.

KPMG Insight: Firms to take into consideration the work programme outlined by the FSB with regards to interest rate benchmarks and monitor updates provided on the implementation of benchmark reforms and remaining challenges.

17 December 2019 FSB


6. FRC amends FRS 102 for interest rate benchmark reform

The Financial Reporting Council announced amendments to specific hedge accounting requirements in FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland to provide relief that will avoid unnecessary discontinuation of hedge accounting during the period of uncertainty. Entities will apply specific hedge accounting requirements assuming that the interest rate benchmark relevant to hedge accounting is not altered as a result of the interest rate benchmark reform. The amendments are effective for accounting periods beginning on or after 1 January 2020, with early application permitted.

KPMG Insight: Whilst this update has an impact on financial institutions adopting FRS 102 only, market participants should follow the latest developments in the IASB’s exposure draft results in relation to IFRS 9 and IAS 39. The exposure draft was released in May 2019 and is currently being analysed and finalised by the IASB.

17 December 2019 FRC


7. FSB publishes its Annual Progress Report on Reforming Interest Rate Benchmarks

The annual progress report published by the Financial Stability Board (FSB) recognises the developments made across jurisdictions in their transition to robust financial benchmarks, however, simultaneously highlights areas which call for sustained efforts by the official sector and firms to transition away from LIBOR in order to avoid significant financial and reputational risks. Further, it warned regulated firms on increasing scrutiny of their transition efforts as the end of 2021 approaches.

KPMG Insight: The year of 2020 is expected to entail regulators and industry-wide bodies issuing surveys globally to firms to ascertain the progress and identify issues (if any) in their transition away from LIBOR. The focus of the surveys is expected to track progress made in embedding appropriate and adequate fallback language in the impacted contracts, education of and negotiation with clients regarding fallback provisions and senior management accountability duties in relation to LIBOR transition.

18 December 2019 FSB


8. ISDA launches Consultation on Fallbacks for Euro LIBOR and EURIBOR

The International Swaps and Derivatives Association (ISDA) has launched a consultation seeking input on the approach for addressing certain issues associated with adjustments that would apply to €STR if fallbacks in EURIBOR or EUR LIBOR take effect, including the final parameters for these adjustments. It also asks about adjustments that could apply if fallbacks take effect in less widely used IBORs. Based on the responses to this consultation, ISDA will determine whether to implement the same adjustments in fallbacks for EUR LIBOR and EURIBOR as the adjustments that are being implemented in fallbacks for GBP LIBOR, CHF LIBOR, JPY LIBOR, TIBOR, Euroyen TIBOR, BBSW, USD LIBOR, CDOR, and HIBOR. The deadline for responses to the consultation is January 21, 2020.

KPMG Insight: Fallback provisions for derivatives instruments referencing major currencies are nearly in place now. Financial institutions should perform a reconciliation between the fallback triggers available for cash instruments with those available for derivatives to avoid hedging mismatches.

18 December 2019 ISDA


9. UK RFRWG Issues Consultation on Credit Adjustment Spread Methodologies for Fallbacks in Cash Products Referencing GBP LIBOR

The Working Group on Sterling Risk-Free Reference Rates (UK RFRWG) has designed a consultation paper targeting cash market participants that considers how to approach the differences between GBP LIBOR and SONIA, i.e. the credit adjustment spread when considering fallbacks to their contracts. In the world of derivative markets, the International Swaps and Derivatives Association (ISDA) has been in the process of consulting derivatives market participants on fallbacks.

KPMG Insight: Market participants should take into consideration the credit spread methodology outlined by ISDA for cash products and provide feedback on the consultation paper by February 6, 2020 regarding appropriate methodologies for credit adjustment spreads in the cash markets.

December 2019 UK RFRWG

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Marie Gervacio
Partner, Financial
Risk Management
KPMG China
Desmond Yu
Associate Director,
Financial Risk Management
KPMG China
Tom Jenkins
Partner, Head of Financial
Risk Management
KPMG China
Simon Topping
Regulatory Advisory
KPMG China
Michael Monteforte
Financial Risk Management
KPMG China