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. ECB Publishes Results of Preparedness Survey for Benchmark Rate reforms
The European Central Bank (ECB) published the results of its industry-wide assessment of banks’ preparedness for the benchmark interest rate reforms. The results found that banks are not sufficiently prepared for the benchmark rate reforms. Despite that EURIBOR is currently the most frequently used benchmark rate for contracts in the euro area, the ECB suggested banks should equally focus on the transition of EONIA and EURIBOR.
The ECB Banking Supervision also published a report on the preparations for benchmark rate reforms which outlines good practices on how banks can best structure their transition governance, identify the related risks, and create action plans and documentation in relation to the reforms.
KPMG’s perspective: Regulators around the globe are putting more pressure on financial institutions to expedite the transition. When reviewing the transition plans, banks should make reference to the ECB’s survey results and examples of good practice to assess the need for additional measures.
23 July 2020 ECB
2. FFIEC Issues Statement on Managing the LIBOR Transition
The members of the Federal Financial Institutions Examination Council (FFIEC) issued a statement highlighting the risks that will result from the transition away from LIBOR, and encouraged supervised institutions to continue their efforts to transition to alternative reference rates in order to mitigate financial, legal, operational, and consumer protection risks. In particular, the statement raises the legal and consumer compliance risks arising from inadequate fallback language if it does not contemplate LIBOR’s permanent discontinuance. The statement also identifies the areas where supervisory staff will focus on when carrying out their reviews of LIBOR transition planning and risk mitigation efforts.
KPMG’s view: Consistent with our observations, many institutions are facing challenges in managing the legal and conduct risks arising from the contract changes. This statement reiterates the importance of identifying and addressing the existing contracts with inadequate fallback language, and put in place the appropriate process that is commensurate with the size and complexity of their exposure. Many institutions have started to involve their internal or external legal counsels in setting up a framework to address this issue.
1 July 2020 FFIEC
3. FSB Issues Statement on the Impact of COVID-19 on Global Benchmark Reform
The FSB issued a statement on 1 July that the FSB’s Official Sector Steering Group (OSSG) was monitoring the developments closely and recognised that some aspects of firms’ transition plans are likely to be temporarily disrupted or delayed by COVID-19. However, the FSB maintains its view that firms should continue their efforts in preparing for IBORs transition and in particular to remove remaining dependencies on LIBOR by the end of 2021.
KPMG’s view: Following the FCA’s statement earlier this year, the FSB statement further reinforces that LIBOR’s end game will happen by the end of 2021 amid the market disruption events. Although COVID-19 is causing continued disruptions to firms’ operations, institutions should no longer expect a delay in LIBOR discontinuation.
1 July 2020 FSB
1. ISDA Board Publishes Statement on Adherence to the IBOR Fallback Protocol
The ISDA published a statement on 29 July 2020 from its Board of Directors on adherence to the forthcoming IBOR Fallback Protocol. ISDA will soon amend certain ‘rate options’ in the 2006 ISDA Definitions to include fallbacks that would apply upon the permanent discontinuation of LIBOR and other key IBORs and upon a ‘non-representative’ determination for LIBOR by publishing the IBOR Fallback Supplement. The new fallbacks will be based on adjusted versions of the risk-free rates identified as alternatives to LIBOR and other IBORs in the relevant jurisdictions. ISDA expects the new protocol which will be soon published can facilitate multilateral amendments to include the amended floating rate options, and therefore the fallbacks, in legacy non-cleared IBOR derivatives contracts.
The protocol will be completely voluntary and will amend contracts only between two adhering parties. The fallbacks are targeted to take effect in new contracts via the IBOR Fallback Supplement and in legacy contracts that are amended by the IBOR Fallback Protocol (or bilaterally) on a set date approximately three to four months after the upcoming launch.
KPMG’s view: We understand that the updated ISDA definitions and transition protocol are pending for final approval from the regulator(s) and will be released shortly. This ISDA statement helps all financial institutions to get ready once the protocol is confirmed. Market participants globally that have non-cleared derivatives exposure to LIBOR and other IBORs should take into consideration the forthcoming IBOR Fallback Protocol when amending their legacy derivatives contracts with their adhering parties.
29 July 2020 ISDA
2. ARRC Publishes SOFR "In Arrears" Conventions for Syndicated Business Loans
The ARRC released conventions related to using the SOFR in arrears, both daily simple SOFR and daily SOFR compounded in arrears, in syndicated loans. The calculation of interest using daily SOFR rates should be published during the relevant interest periods instead of over a period of time prior to the start of the interest periods. The recommended conventions address both new loans that are originated using SOFR and legacy loans that “fall back” from LIBOR to SOFR upon LIBOR cessation or LIBOR being declared to be unrepresentative.
KPMG’s view: Financial institutions offering syndicated loans should carry out an analysis to check whether the new recommended conventions are applicable to their contracts for both new SOFR syndicated loans and legacy LIBOR syndicated loans converting to SOFR. Financial institutions, especially the lead banks of the syndications, should consider adding the updated fallback language for USD LIBOR syndicated loans in the ARRC’s recommendations issued on 30 June 2020.
22 July 2020 ARRC
3. Bloomberg Begins Publishing Calculations Related to IBOR Fallbacks
Bloomberg and the International Swaps and Derivatives Association (ISDA) announced in July 2020 that Bloomberg Index Services Limited (BISL) has begun calculating and publishing fallbacks that ISDA intends to implement for certain key interbank offered rates (IBORs).
In July 2019, ISDA announced that Bloomberg had been selected to calculate and publish these adjusted risk-free rates (RFRs) as fallbacks following an in-depth selection process. The calculations published by BISL include adjusted RFR (compounded in arrears), the spread adjustment and the ‘all in’ IBOR fallback rates for the IBORs including LIBOR across various tenors, which will be made available to industry participant through various distribution channels, including the Bloomberg Terminal. The new fallbacks will be incorporated in ISDA’s amendments to its standard interest rate derivative definitions based on the market feedback.
KPMG’s view: The publishing of new fallbacks and spread adjustments is a promising move to encourage financial institutions to perform quantitative financial impact assessment arising from the change of reference rate. With the “all in” fallback rates, financial institutions can have a clearer picture of the spread adjustments and the respective basis risk management.
21 July 2020 ISDA
4. ISDA Releases Interest Rate Benchmarks Review on the First Half and Second Quarter of 2020
The ISDA released a research paper “Interest Rate Benchmarks Review: First Half of 2020 and Second Quarter of 2020” to provide an overview of market exposure to interest rate derivatives referencing alternative risk-free rates. The results showed both the traded notional and trading volumes of IRD transactions have been increased continuously. The paper uses data from the Depository Trust & Clearing Corporation (DTCC) swap data repository, which only covers trades that are required to be disclosed under US regulations.
KPMG’s view: Out of all RFR-referencing interest rate derivatives, SONIA and SOFR had the most significant increase during the period (120% and 79% respectively) which outweighs the LIBOR denominated interest rate derivatives (22%). This is a promising sign that market liquidity continues to build up in the RFR derivative markets. Financial institutions should continue to monitor the volume of RFR trades in the market especially when starting to write new RFR products in Q4 2020.
21 July 2020 ISDA
5. ISDA Releases a New Brochure About the Benchmark Reform
The ISDA released a new Brochure “Benchmark Reform at a Glance” which provides an overview of steps that firms can take to reduce their exposure and prepare for the IBORs transition. The brochure covers the suggested measures to reduce the exposure to LIBOR or another LIBOR; solutions if the firms still have exposure to LIBOR (or another IBOR) at the time it is discontinued; and explanation on pre-cessation fallback for LIBOR.
KPMG’s view: The ISDA brochure provides clear and concise explanations in the form of Q&A. This is a good document that financial institutions could circulate within the firm as a market update to all stakeholders that have existing ISDA contracts.
16 July 2020 ISDA
6. ASIFMA Releases Industry Guide for IBOR Transition in Asia
The Asia Securities Industry & Financial Markets Association (ASIFMA) published a paper “IBOR Transition Guide for Asia” on 13 July 2020. The paper provides an overview of the key implementation issues to be considered by financial institutions in Asia in preparing the transition from the LIBOR by the end of 2021.
Additionally, the paper includes a practical implementation checklist for financial institutions to use as a reference, which covers: (1) program governance; (2) transition management program; (3) communication strategy; (4) identify and validate exposures; (5) develop product strategy; (6) risk management; (7) transition of existing contracts and new contracts; (8) operational and technology readiness; (9) accounting and reporting; and (10) taxation.
KPMG’s view: The paper is prepared based on the practical experience in the Asian market specifically which is a good reference material for Asian financial institutions to plan and implement their transition plan. The checklist is a good guide for financial institutions to check against their existing transition plan to ensure the key transition activities are covered and planned.
13 July 2020 ASIFMA
7. FSB and BCBS Report to the G20 on Supervisory Issues Associated with Benchmark Transition
The Financial Stability Board (FSB) and Basel Committee on Banking Supervision (BCBS) have published a report to the G20 on supervisory issues associated with benchmark transition. The report outlines the remaining challenges for LIBOR transition based on surveys undertaken by the FSB, the BCBS and the International Association of Insurance Supervisors (IAIS), in the areas including the exposure to LIBOR transition, preparation of transition strategy, transition monitoring, transition risks, etc.
The report concluded that continued reliance of global financial markets on LIBOR poses clear risks to global financial stability. Most FSB jurisdictions have a strategy in place to address LIBOR transition, as opposed to only half of the surveyed non-FSB jurisdictions. In light of the survey results, the report also provided a set of recommendations to support authorities and firms in their transition efforts.
KPMG’s view: The publication provides a snapshot of financial institutions’ readiness in the LIBOR transition globally, and sets out comprehensive details in respect of the challenges and recommendations. Financial institutions are recommended to study this report and update their implementation plan as they see fit. In addition, Arthur Yuen, Deputy Chief Executive of HKMA, gave a presentation at an ASIFMA virtual event discussing the findings of this report. The playback is available at the ASIFMA website.
9 July 2020 FSB
8. ARRC Releases Internal Systems Processes Transition Aid Tool for LIBOR Transition
The Alternative Reference Rates Committee (ARRC) released the taxonomy “Internal Systems and Processes: Transition Aid for SOFR Adoption” to aid market participants to structure their transition away from LIBOR. The taxonomy tool provides a clear summary of processes and systems that may require enhancements for a smooth transitioning to the Secured Overnight Financing Rate (SOFR).
The taxonomy tool broadly classifies transition activities into the following categories: (1) product and business development; (2) trading and brokerage; (3) client servicing; (4) trading risk management; (5) data management; (6) operations; (7) risk controls; (8) financial controls; (9) legal and compliance; and (10) information technology. It also summarises the upstream and downstream areas that may be affected by the transition as well as dependencies that may influence the timing and sequence of transition activities.
KPMG’s view: The document is a comprehensive guide to assist financial institutions in compelling an inventory of the internal systems and processes that need to be transitioned to SOFR. The guide walks through the end-to-end trading cycle and identifies the respective impacts from the perspective of activities, systems, processes and other dependencies. The document contemplates most banking activities, therefore should be reviewed by all types of financial institutions.
8 July 2020 ARRC
9. ICE Benchmark Administration Launches Beta Version of ICE Term SONIA Reference Rates
The Intercontinental Exchange (ICE) announced on 8 July 2020 to launch an initial beta version of its ICE Term SONIA Reference Rates which are designed to measure average expected (i.e. forward-looking) SONIA rates over one month, three month and six month tenor periods on a daily basis. The beta rates are only for information and testing purposes before it is made available as a benchmark for use in financial instruments. The beta rates are developed under a Waterfall Methodology and have used eligible SONIA-linked interest rate derivative product data.
KPMG’s view: Following the trial version of SOFR term curves published by Bloomberg, this is the second term curve built for the alternative reference rate. Certain banks in Hong Kong have started to consider building or replicating the term curves as part of the system changes arising from LIBOR transition. We expect to see an increasing trend on the RFR liquidity especially in the derivative market, which would help to build the maturity of the RFR term curves in the future.
8 July 2020 ICE
1. KPMG Sponsors the “Letting go of LIBOR – how banks and buy-side firms are navigating the road to transaction” report of Risk.net
As the LIBOR-to-RFR transition gathers pace, this industry survey by Risk.net and KPMG provides a unique insight into the strategies deployed so far by the financial organisations and corporates facing this major market shift.
6 August 2020 Risk.net
Head of Financial
Financial Risk Management
Financial Risk Management
Financial Risk Management
Financial Risk Management