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.
Practical guidance on frameworks and practices has been set out for both buy-side and sell-side entities to adopt for manging conduct risk during the transition of London Inter-Bank Offered Rate (LIBOR). This information sheet (INFO 252) also provides specific guidance and recommendations for buy-side entities and non-APRA-regulated Australian financial services (AFS) licensees. ASIC covers five areas in their guidance, which are “Treating clients fairly”, “Performance of products and services”, “client communication”, “Risk Management Framework” and “Buy-side entities’ responsibilities”. In respect to buy-side entities, ASIC suggested the quality and effectiveness of their trustee duties and as responsible entities are required to be accessed under LIBOR transition. As a trustee, the inadequate preparation for LIBOR transition might affect the effectiveness regarding the duty to supply information, duty to invest and duty of loyalty to beneficiaries.
KPMG’s perspective: In response to ASIC’s information sheet, both buy-side and sell-side entities should take their own preparations regarding the LIBOR transition. The responsibilities do not solely fall on sell-side entities. In order to mitigate the conduct risks, it is recommended to follow the practices advised by ASIC where applicable. All financial institutions are strongly encouraged to provide transparent and informative material to clients and educate them during the LIBOR transition. When an entity is proposing fallback terms to clients for legacy contracts, any potential conflicts of interest should be identified and mitigated. Reputational risk is one of the risks which might arise during transition. Proactive and on-going communication with clients is essential. All regulated financial institutions are advised to look into all possible options proposed by the regulators when preparing for the firm-wide communication plan from now to the end of 2021, in order to meet all regulatory requirements.
30 November 2020 ASIC
2. The Bank of Thailand has recommended the Thai Overnight Repurchase Rate ("THOR") as the alternative benchmark rate
The Bank of Thailand (BOT) has announced the Transition Milestones to Thai Overnight Repurchase Rate (THOR), which is the alternative reference rate launched in April 2020. The current Thai Baht Interest Rate Fixing (THBFIX) will be discontinued along with USD LIBOR, which is one of the calculated inputs. All financial institutions are encouraged to step back from THBFIX and to accelerate the adoption of THOR. Understood that it might take time to develop THOR, the steering committee and the TOB would provide the fallback rate of THBFIX as a temporary stopgap for around 3 years. The BOT expects the transition from THBFIX to THOR should be completed by then. The fallback rate is targeted for legacy contracts. For new cash products, the usage of the fallback rate is strictly prohibited. The cessation of THBFIX would be announced by the BOT when USD LIBOR is discontinued. As a result, fallback rate will become effective since then. The BOT expects these events to happen at the end of 2021.
KPMG’s perspective: Banks and investors should take prompt action according to the timeline published by BOT if they have any THB exposures, such as IRS, CCS and loans. Similar to other jurisdictions, banks are encouraged to have the ability to launch new products that are referenced to THOR at their soonest. The fallback arrangement and customer communication are still the key when transiting to THOR for legacy products with the maturity date after the end of 2021. Even the fallback rate is still available and expected to discontinue in 2024, Financial Institutions are still encouraged to reduce the THBFIX exposure as soon as possible. Even there is no strict limitation in using THBFIX for new derivatives contracts, it should be avoided unless absolute necessary in case there is a change of timeline announced by the regulator.
17 November 2020 TOB
The ARRC published the latest convention and guideline for bilateral loans. It includes both daily simple SOFR and daily compounded SOFA in arrears, when the industry uses the Secured Overnight Financing Rate (SOFR) in arrears. The latest convention aligns with the objectives set by ARRC in 2020. Further to the convention, published in July for using SOFR in arrears for syndicated business loans, this is a key milestone for this year by providing supporting materials for Bilateral loan. However, it might not be applicable for the business loan markets in all segments because the convention is not compulsory. Other than the convention, ARRC urges all market participants to step away from LIBOR and transit to SOFR.
KPMG’s perspective: The recommendations released by ARRC help to provide the industry with more guidance regarding the LIBOR transition, especially for the fallback approach and ARR products’ development. For bilateral loans or syndicated business loans, it is still recommended to use daily simple SOFR or daily compounded SOFR in arrears under the hardwired approach. SOFR term rate, if available, would tend to have conventions similar to the current term LIBOR. However, while the term rates are being developed, banks should consider and reference to the conventions and information by published by ARRC to be prepared for the transition.
25 November 2020 ARRC
2. ARRC released FAQs for Business Loans Hardwired Fallback Language
The FAQs have covered and answered some enquiries regarding the hardwired approach in fallback language for business loans. The pre-cessation trigger in ISDA’s supplement and Protocol and the ARRC’s fallback language recommendation for cash products could occur simultaneously, i.e. when LIBOR becomes non representative. Besides, ARRC announced the spread adjustment will be set on the same date as ISDA’s spread adjustment. This implies ISDA and ARRC are aligned, in respect to timing of effectiveness and the spread of adjustments that would apply to fallback. Furthermore, ARRC recommends the spread adjustment will be linked to tenor of benchmark rate instead of the frequency of payment when the existing term rate Benchmark, such as LIBOR, does not match the payment period for payment of interest. If multiple tenors available for an existing loan facility, i.e. at borrowers’ elections in choosing the tenor, the spread is approximately equal to each payment period depending which tenor is chosen during the loan application.
KPMG’s perspective: The FAQs help to clarify some common questions arising from the LIBOR transition. They are useful for banks in preparing the fallback languages for business loans. Based on the FAQs, the pre-cessation trigger in benchmark transition event, the date and spread adjustment between ISDA and ARRC are aligned with each other. This helps to reduce the potential basis risk derived from the mismatch between the loans and derivatives.
25 November 2020 ARRC
3. ICE Benchmark Administration to Consult On Its Intention to Cease the Publication of GBP, EUR, CHF and JPY LIBOR
ICE Benchmark Administration (IBA) has made its announcement on the consultation to cease the publication of all existing GPB, EUR, CHF and JPY LIBOR tenor rates after 31 December 2021. This has aligned with the intention announced by FCA in July 2017 regarding the necessity to persuade, or compel, banks to submit to LIBOR after 31 December 2021. FCA also consults on new benchmarks power. It is not envisaged to intervene the cessation under the current proposed policy. The EUR and CHF LIBOR should not require the power from FCA to continue the publication at the time these panels are proposed to cease. Nonetheless for GPB LIBOR, there is possibility to require FCA intervention and the conditions of using the power are more likely to be met under the current proposal when the GPB LIBOR term rates are to be ceased. There are tough legacy contracts exist in the sterling market with remarkable amounts.
KPMG’s perspective: All financial institutions should take note of this proposal and review their current exposure for these 4 currencies that are referencing to LIBOR. They should follow the timeline and guideline set by the regulators to proactively take actions regarding LIBOR transition. Banks should prioritise and review if there are any tough legacy contracts which might be more complicated in arranging the fallback language for such currencies exposure in order to meet the regulatory deadline, especially for GBP that is advised by the FCA. Banks should also start educating and providing training to internal staff and have a solid communication plan to consumers so as to have a smooth transition process for those tough legacy contracts.
18 November 2020 ICE
4. ICE Benchmark Administration Proposes Extension of Most USD LIBOR Tenors Through June 2023
Further to the announcement made on 18 November 2020, ICE has announced the proposal and its consultation paper for the USD LIBOR for overnight, 1-month, 3-month, 6-month and 12-month tenor rate to be published until 30 June 2023. But for the publication of USD LIBOR 1-week and 2-month tenor rate would be ceased after the publication after 31 December 2021, together with all GBP, EUR, CHR and JPY LIBOR Tenor rates. FCA welcomed the extension for some LIBOR tenor rates and support the proposal on consulting the clear cessation date of LIBOR tenor rates. FCA will coordinate with the US authorities as well as relevant authorities in other jurisdictions to limit the new use of USD LIBOR. The limitation will be aligned with the objectives of protecting consumers and promoting market integrity. Even there is proposal of extending some USD LIBOR term rates, FCA still encourages all market participants to continue working on converting the legacy contracts from LIBOR to RFR, especially on the fallback arrangement to tough legacy contracts. The Federal Reserve, Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency co-published a statement which continues to encourage banks to cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and in any event by 31 December, 2021, in order to facilitate an orderly—and safe and sound— LIBOR transition
KPMG’s perspective: The potential extension of USD LIBOR rates might be able to relieve some stress from migrating “tough” legacy contracts. Extending the publication of certain USD LIBOR tenors until June 30, 2023 would allow the legacy USD LIBOR contracts to mature before LIBOR experiences disruptions. However, financial institutions are still urged to cease entering into new contracts that use USD LIBOR as a reference rate maturing post 31 December 2021. The HKMA has not yet announced any delay to the original transition timeline which was published in July. All authorised institutions (AIs) should follow their current project timelines for LIBOR transition to have the ability to issue new RFR products since 1 January 2021 and no issuance of new products that are referenced to LIBOR with the maturity date after 31 December 2021.
30 November 2020 ICE
New Developments on Products and Pricing Strategy
HSBC announced the execution of the pilot USD SOFR trade loan transaction for Charter Link Limited, a textile and garment company in Hong Kong. The trade loan is for the funding to procure raw materials from overseas. This marks the first SOFR-referenced trade loan in the local business community. It is another step by HSBC in contributing to the development of the SOFR market after its earlier execution of first HONIA-SOFR cross currency swap in Hong Kong.
20 November 2020 HSBC
KPMG’s perspective: This product development has enriched and provided more market insights on the SOFR market for trade finance products. This is one of the global milestones demonstrating that not only big corporations or financial firms are willing to buy new alternative risk-free rate (RFR) products but also the local commercial business clients. It can be expected that when there are more SOFR loans or trade finance products launched in the market, the development in other derivatives, such as SOFR IRS or CCS, will be boosted. Considering there may be increasing demands in hedging on interest rate risks resulting from the growing local capital markets, this could also be a useful benchmark for local financial institutions in developing their own ARR-based derivatives instruments in time.