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. FRC publishes amendments to FRS 101 and FRS 102
On 2 June 2020, the Financial Reporting Council (FRC) published minor amendments to the FRS 101 and FRS 102 framework, applicable to all UK and Republic of Ireland qualifying entities. The FRC carries out an annual review of the FRS 101 Reduced Disclosure Framework which provides additional exemptions as IFRS evolves and covers responses to industry feedback on other possible improvements. The amendments provide exemptions from the disclosures of cash flows. A similar amendment is made in FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland for qualifying entities.
KPMG Insight: The second phase of amendments by the FRC focuses on minimising discontinuities in the accounting for financial instruments and leases, avoiding discontinuation of hedge accounting for modifications to agreements in order to transition to alternate benchmark rates, and reducing reporting costs. Relevant entities should take into consideration the amendments and assess the re-estimations required for cash flows in line with the market rates of interest. The FRS 102 amendments will be effective on or after 1 January 2021.
2 June 2020 FRC
2. Bank of Japan (BOJ): Letters to the CEOs
The Bank of Japan, together with Financial Services Agency, have written a letter to CEOs of large financial institutions with regards to LIBOR transition. The letter requires these institutions the submission of relevant materials in relation on their LIBOR transition plans in order for the BOJ to ascertain whether the Board of Directors and senior management have sufficiently understood and evaluated the risks arising from the cessation of LIBOR, including appropriate actions to manage and mitigate identified risks.
KPMG Insight: Financial institutions are expected to have in place robust transition plans evidencing approval from the Board of Directors and Senior Management, as well as regular progress reporting on the transition plan. Client outreach programmes must be in place, with adequate and timely training provided to staff on the relevant issues and risks related to permanent cessation of LIBOR. The range of potential impacts include IT systems, operational rules and procedures, clear documentation, and quantification. Accounting and disclosure policies affecting the financial statements and investor relationships must also be understood and addressed. Financial institutions are required to submit the required materials by Friday 10 July.
1 June 2020 BOJ
3. The Bank of England’s Market Notice on approach to collateral referencing LIBOR for use in the Sterling Monetary Framework
The Bank of England (BoE) published a market notice on risk management approaches to collateral referencing LIBOR for use in the Sterling Monetary Framework. A haircut add-on will be applied to all LIBOR-linked Collateral from April 2021. In addition, for loan portfolios containing both LIBOR-linked loans and other loans, SMF participants may choose to either remove the LIBOR-linked Loans from the Loan Portfolios, or alternatively split these Loan Portfolios, subject to them meeting the Bank’s standard collateral eligibility requirements. The market notice also states that LIBOR-linked Collateral maturing after December 2021 will be ineligible for use in the Sterling Monetary Framework from April 2021. In relation to fallback language, the BoE will continue to monitor market developments and will keep under review the potential to distinguish between LIBOR-linked Collateral with robust fallback language and that without, as market practice develops.
KPMG Insight: Institutions should carry out an analysis on their loan contracts to identify those that are ineligible for use in the Sterling Monetary Framework. In addition, firms should also monitor for industry guidance on fallback language in relation to LIBOR-linked Collateral.
7 May 2020 BOE
4. ASIC letter to large corporations on the preparation for LIBOR transition
In May 2020, the Australian Securities and Investment Commission (ASIC) requested a number of large corporations to prepare for their LIBOR transitions to alternate risk free rates. ASIC requires firms to conduct a LIBOR ‘stocktake’ and identify the areas of the organisation affected by LIBOR. The letter references various industry bodies for publications on transition guides and industry consultations that may assist with the transition.
KPMG insight: ASIC requires firms to assess whether LIBOR is used as part of discount rates in valuation models or in other accounting methodologies and tax treatments. In addition, firms are required to assess the impact of LIBOR on the various areas of the organisation and carry out client outreach to ensure informed decisions are made and avoid legal, financial, and litigation risks.
May 2020 ASIC
5. The RFRWG, the FCA, and the Bank of England Issue Further statement on the Impact of Coronavirus on the Timeline for Firms’ LIBOR Transition Plans
On 29 April 2020, the FCA and the Bank of England joined with members of the Working Group on Sterling Risk-Free Reference Rates (RFRWG) and its sub-groups and task forces to issue a statement providing their views on how all firms’ LIBOR transition plans may be impacted by Coronavirus, further to the joint statement made on 25 March 2020. In the light of the current operating environment impacted by coronavirus, the RFRWG, the FCA, and the Bank of England expected that it will not be feasible to complete a transition away from LIBOR across all new sterling LIBOR-linked loans by the original end-Q3 2020 target, though continued progress on LIBOR transition in sterling cash markets and loan markets was observed.
It was anticipated there will be continued use of LIBOR-referencing loan products into Q4 2020, in particular, to maintain the smooth flow of credit to the real economy. Taking this into consideration, the RFRWG recommended that
- By the end of Q3 2020 lenders should be in a position to offer non-LIBOR linked products to their customers
- After the end of Q3 2020 lenders, working with their borrowers, should include clear contractual arrangements in all new and re-financed LIBOR-referencing loan products to facilitate conversion ahead of end-2021, through pre-agreed conversion terms or an agreed process for renegotiation, to SONIA or other alternatives; an
- All new issuance of sterling LIBOR-referencing loan products that expire after the end of 2021 should cease by the end of Q1 2021.
KPMG Insight: Notwithstanding the delay of the specified transition target by the end of Q3 2020, the FCA has stated its view clearly that the target of complete transition away from LIBOR by the end of 2021 remains unchanged. We noted that many financial institutions in Hong Kong re-prioritised away from their LIBOR transition programs amidst COVID-19 response activities for the past few months. With the COVID-19 situation easing and business operations gradually resuming, financial institutions should accelerate the transition to ensure the completion by the end of 2021.
29 April 2020 FCA
6. The HKMA Releases Results of the Survey on Reform of Interest Rate Benchmarks
Based on the survey conducted by the HKMA in November 2019, the results indicated that a significant LIBOR linked position was maintained in the Hong Kong banking system, where there were HK$4.5 trillion of assets and HK$1.6 trillion of liabilities referencing the LIBOR at the end of September 2019, representing about 30% and 11%, respectively, of the banking system’s total assets and total liabilities denominated in foreign currencies. Additionally, there were derivatives contracts involving an aggregate amount of HK$35 trillion in notional value referencing LIBOR. Around one-third of these LIBOR-linked assets and liabilities, and almost half of these derivatives contracts would mature after end-2021 and did not have adequate fall-back provisions.
The survey results also reflected that many Banks in Hong Kong had commenced the transition preparation and established a committee or appointed a senior executive to oversee the preparatory work and the development of a firm-wide transition plan. Some major challenges have been cited by the respondent banks in preparing for the transition.
As further mentioned in the result statement, the Working Group on Alternative Reference Rates formed in Hong Kong under the Treasury Markets Association (TMA) has been following up on issues that need to be addressed locally (e.g., taxation). The HKMA will continue to use the survey to monitor the banking sector’s preparation for the transition.
KPMG Insight: The HKMA survey results confirm the fact that the LIBOR linked positions in Hong Kong is financially significant. While more than half of the surveyed banks have established a steering committee and/or appointed a senior executive overseeing the preparation for the transition, it is alarming to see only 38% have developed a bank-wide transition plan as of the survey submission date in December 2019. We believe that, while more banks have made progress in the development of bank-wide transition plans in Q1 2020, financial institutions should also make plans to renegotiate existing LIBOR-linked contracts that go beyond 2021, as well reduce the LIBOR exposures by introducing new ARR producs.
23 April 2020 HKMA
7. ASIC Releases Feedback on Financial Institutions’ Preparation for LIBOR Transition
The Australian Securities and Investments Commission (ASIC) has released feedback on Australian institutions’ preparation for the end of LIBOR which is supported by the Australian Prudential Regulation Authority (APRA), and the Reserve Bank of Australia (RBA). To ensure a smooth transition, Australian financial institutions are urged to plan early given the potential for significant reputational, operational, and legal risks posed by the transition, and the impact to the financial markets overall, if transition activities do not progress adequately.
As outlined in the feedback, a set of best practices has been provid:
- Formalise a transition program that identifies risks, mitigation strategies, and timelines;
- Conduct a comprehensive assessment of how LIBOR affects an institution’s business and quantify LIBOR-related Focus on client outreach and communication programmes to ensure clients are aware of the transition risks;
- Participate in industry forums and keep abreast of market developments and co-ordinated actions being taken within the industry;
- Seek legal advice on contract amendment and fall-back provisions;
- Assess readiness of IT systems and infrastructure and ensure they can process contracts that reference overnight rates;
- Plan for both base and alternative scenarios, including the adoption of various ARRs;
- Initiate LIBOR transition training programmes for relevant stakeholders, including staff members, Boards and senior management;
- Consider conduct related issues associated with the transition; and
- Ensure there is adequate due diligence, risk assessment, and contingency planning in relation to third-party service providers in the context of LIBOR transition.
KPMG Insight: The best practice suggested by ASIC largely resembles the HKMA’s feedback from their November 2019 survey on the common challenges faced by authorised institutions in Hong Kong, as well as the transition framework suggested by KPMG. The feedback helps to reiterate the key steps to ensure a successful and smooth transition. Based on our continuous conversations with market participants across the region, most banks have formed their transition programs and are currently preparing for the comprehensive quantification of LIBOR exposures across five key aspects: exposures, contracts, systems, models, and processes.
8 April 2020 ASIC
1. ARRC best practices for completing the transition from LIBOR
The Alternate Reference Rates Committee (ARRC) published best practices to assist market participants with their preparation for the cessation of U.S. dollar (USD) LIBOR. The ARRC has recommended that financial institutions consider the following guidance:
- New USD LIBOR cash products should include ARRC-recommended fallback language
- All technology and system enhancements to support SOFR should be completed by the end of 2020
- For contracts where discretion is left to the determining party to select a replacement rate, the planned selection should be disclosed to relevant parties six months prior to the date that a replacement rate would be effective
The ARRC best practices include recommendations for the various products, including floating rate notes, business loans, and securitizations and derivatives for which institutions must take active steps to meet the timelines set out. In addition, institutions should ensure they have clear transition plans in place to move away from USD LIBOR across all activities, including rigorous assessment of exposures. In the event USD LIBOR is no longer useable, firms should incorporate additional ARRC-recommended conventions into new contracts to support robust contract language.
27 May 2020 ARRC
2. ISDA provides responses on the implementation of pre-cessation fallbacks
In July 2020, ISDA proposes to publish its amendments to the 2006 ISDA definitions to incorporate fallbacks for new trades. In January 2020, ISDA published a pre-cessation consultation which required market participants to answer a ‘yes’ or ‘no’. The preliminary findings from the report highlight that most respondents are in favour of including the pre-cessation fallbacks in ISDA documentation: for new contracts, through amended versions of the ISDA 2006 definitions, and for legal contracts, through a protocol.
KPMG Insight: ISDA is expected to move forward on the basis that for all new and legacy derivatives referencing LIBOR that incorporate the amended 2006 ISDA Definition, the pre-cessation fallbacks based on a ‘non-representativeness’ determination and permanent cessation fallbacks would apply to all new and legacy derivatives referencing LIBOR that incorporate the amended 2006 ISDA Definitions. Financial institutions should assess the contracts for which the amended 2006 ISDA definitions will apply.
14 May 2020 ISDA
3. Bloomberg Publishes a Rulebook for IBOR Fallback Methodology
Bloomberg Index Services Limited (Bloomberg), selected by ISDA in 2019 as the vendor to calculate and publish adjustments related to fallbacks for certain interest rate benchmarks, published a Rulebook on 23 April 2020 setting out final methodologies for the fallbacks of certain key IBORs via a Supplement to the 2006 ISDA Definitions and related Protocol.
While alternative RFRs are different in nature compared to IBORs, corresponding adjustments are necessary for RFR fallbacks on LIBOR-linked contracts. The final adjustment methodology by Bloomberg is based on the results of consultations conducted by ISDA. The rulebook has not yet covered pre-cessation fallbacks for LIBOR which is expected to be updated later.
KPMG Insight: The finalisation of adjustment methodology for IBOR fallbacks is a promising development in the LIBOR transition journey, which sets the foundation for the adoption of RFRs. Financial Institutions should assess and prepare to implement the final fallback adjustment methodology in their contracts expiring beyond the end of 2021, together with appropriate fallback language provided by other regulatory and industry bodies.
23 April 2020 ISDA
4. ARRC Announces Its Key Objectives for 2020
On 17 April 2020, ARRC announced a set of key objectives for 2020 aiming to achieve market readiness and support the voluntary adoption of SOFR as an alternative to USD LIBOR. The objectives covered the following core tenets:
- Supporting SOFR use and liquidity;
- Encouraging the development and strengthening of market infrastructure and operations to support SOFR;
- Creating and encouraging the use of robust contractual fallbacks;
- Developing materials to support consumer education and outreach efforts;
- Increasing clarity on key legal, tax, accounting, and regulatory matters; and
- Advancing outreach, education, and global coordination.
In line with the above objectives and to minimise legal uncertainty and adverse economic impacts associated with the LIBOR transition, ARRC is also pursuing legislative relief for legacy LIBOR-linked contracts that may be otherwise difficult to amend and that do not have economically appropriate fallbacks.
KPMG Insight: The ARRC objectives for 2020 align with the focus areas for the upcoming transition tasks this year. These objectives can directly address the key challenges faced by financial institutions, as indicated in the HKMA survey results (refer to update #2 in regulatory updates). Financial institutions should keep track of further guidance to be provided by the ARRC and other industry bodies to ensure a seamless transition process.
17 April 2020 ARRC
5. ISDA Announces Preliminary Results of Consultation on Pre-cessation Fallbacks for LIBOR
On 15 April 2020, the International Swaps and Derivatives Association (ISDA) announced the preliminary results of its consultation on the implementation of pre-cessation fallbacks for derivatives referenced to LIBOR. The results showed that majority of respondents in the consultation support to include both pre-cessation and permanent cessation fallbacks as standard language in the amended 2006 ISDA Definitions for LIBOR and in a single protocol for including the updated definitions in legacy trades.
ISDA expects to move forward on the basis that pre-cessation fallbacks based on a “non-representativeness” determination and permanent cessation fallbacks would apply to all new and legacy derivatives referencing LIBOR that incorporate the amended 2006 ISDA Definitions. The updated definitions for other covered IBORs will continue to include permanent cessation fallbacks only.
KPMG Insight: The conclusion derived from the consultation provides further progress in the finalisation of the revised ISDA protocol for fallback provisions. The other area that still requires market consensus is the pre-cessation trigger which we expect ISDA to provide more guidance on at some point this year.
15 April 2020 ISDA
6. IASB Proposes Further Amendments to IFRS Standards in Response to Interest Rate Benchmark Reform (Phase 2)
The International Accounting Standards Board (IASB) has proposed amendments to IFRS Standards considering and providing additional information on the effects of interest rate benchmarks reform on financial statements. Following the first phase amendments released in September 2019 regarding temporary exceptions and related disclosures to specific hedge accounting requirements, this refers to the second phase of proposed amendments relating to the modifications of the carrying amount of financial instruments, hedge accounting and disclosures aiming to address issues affecting financial statements when changes are made to contractual cash flows and hedging relationships as a result of the LIBOR transition.
KPMG Insight: Whilst the IASB is working continuously to accelerate the finalisation of the amendments to the IFRS Standards, firms should beware and follow the latest updates and in the meanwhile assess the associated impacts on their financial positions and accounting exposures as a result of LIBOR transtion.
9 April 2020 IASB
7. ARRC Announces Recommendation of a Spread Adjustment Methodology for Cash Products
The Alternative Reference Rates Committee (ARRC) has recommended a spread adjustment methodology for cash products referencing USD LIBOR, which market participants can choose to adopt voluntarily. The methodology is developed in line with the approach suggested by ISDA for derivatives, where a historical median over a five-year lookback period is used to calculate the difference between USD LIBOR and Secured Overnight Financing Rate (SOFR). For consumer products, the ARRC is additionally recommending a 1-year transition period to this five-year median spread adjustment methodology. ARRC will release a more detailed final recommendation In the coming weeks and has committed to working with potential vendors to make sure that these spreads and spread-adjusted rates are made publicly available.
KPMG Insight: The recommended methodology is believed to facilitate the LIBOR transition and sets up good guidance, especially for those firms that have yet to start to consider or are planning to use fallback provisions in their LIBOR contracts. This also helps to reduce potential impacts in the change of contract value resulting from the shift of reference rate.
8 April 2020 ARRC
1. Finastra & KPMG webinar: LIBOR Transition in Asia, where are we right now?
With only 18 months left until the 2021 deadline, Finastra, KPMG and industry subject matter experts in this webinar discussed and brought awareness to where banks should stand:
- LIBOR transition progress in Asia Pacific, where are we right now?
- How do banks in Asia look to reduce operational, legal and borrower's costs given the uncertainties and complexities of LIBOR transition globally?
- How does the growing COVID-19 uncertainties impact LIBOR transition and implementation plans?
- Implications and importance of having a comprehensive plan as well as system readiness for the transition from LIBOR to Risk Free Rates which require complex calculations
3 June 2020 Finastra
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