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. KPMG in Asia Pacific releases the ASPAC LIBOR Readiness Report
The report provides an overview – as at the end of September 2019 – of the readiness of banking systems in the Asia Pacific region to transition away from LIBOR, and it offers a detailed plan for how banks can prepare for the end-2021 deadline.
1. BOE warns firms on LIBOR transition
The Bank of England (“BOE”) has warned that it will consider further potential policy and supervisory tools to reduce the stock of legacy LIBOR contracts as it notes firms continuing to write new LIBOR contracts even though LIBOR is expected to be discontinued after the end of 2021.
KPMG Insight: BOE has already expressed its intention to restrict LIBOR collateral in its sterling liquidity pool in the Financial Stability Report issued in July 2019. Some of the other punitive measures at regulators’ disposal could include hiking risk weights of LIBOR-linked assets under Basel III capital rules or appointing an independent party to perform an assessment of a firm’s transition plans and activities to enforce speedy transition to alternative reference rates.
Although these measures may not have direct impact to banks in Hong Kong, we encourage banks in Hong Kong continue to monitor their LIBOR-linked assets. For products that are still priced in LIBOR, banks should consider incorporating suggested fallback provisions into the contracts.
2 October 2019 BOE
2. ECB started to publish €STR
On 2 October 2019, the European Central Bank began publishing the new risk-free rate for Euro markets, i.e. euro short-term rate (“€STR”). €STR will be published on each business day based on transactions conducted and settled on the previous business day (the reporting date “T”).
KPMG Insight: The fixed income markets have been waiting for the publication of €STR, given that the other key risk-free rates, e.g. SONIA and SOFR, have been published for a period of time. It is encouraging to see that European Investment Bank (EIB) immediately issued the very first €STR bond on the same day as €STR was published for the first time. We expect to see the volume of €STR-based products continue to increase and allow a more liquid market for trading.
2 October 2019 ECB
3. BOJ urges widespread action on LIBOR transition
The Bank of Japan (“BOJ”) deputy governor Masayoshi Amamiya called for concerted collective efforts on the transition away from LIBOR. In an industry conference, the governor summarised the initiatives being taken by the Cross-industry Committee on Japanese Yen Interest Rate Benchmarks (the designated committee for interest rate benchmark reform) to raise market awareness and provided a view of upcoming activities in support of a smooth transition to alternative reference rates.
KPMG Insight: Regulators around the globe are urging firms to develop a transition plan and keep track of regulatory and industry developments to avoid an “eleventh-hour” implementation. The message is consistent with other regulators in the world and in the APAC region – banks should not take a sit-and-wait approach for LIBOR transitioning.
10 October 2019 BOJ
4. ECB offers €STR risk management guidance
Following publication of €STR as the new risk free rate for Euro markets, the European Commercial Bank (“ECB”) published a report highlighting the types of risk financial institutions will face during the implementation phase of the transition period and providing recommendations to help market participants prepare for the transition to risk free rates. The report covers four key areas: (i) general risk management considerations, (ii) risk management implications of transitioning from EONIA to €STR, (iii) risk management implications of €STR-based fallback rates from EURIBOR, and (iv) additional risk management considerations for the asset management and insurance sectors.
KPMG Insight: In the report, the ECB has requested financial institutions to develop a robust governance framework and perform an in-depth qualitative and quantitative impact analysis on the EURIBOR-related exposures. This is consistent with our view that financial institutions should start forming their governance framework, assessing risks and different transition scenarios, quantifying LIBOR exposures, and simultaneously developing a client outreach plan as soon as possible.
17 October 2019 ECB
5. NY Fed on SOFR spike
John C. Williams, the President and CEO of the Federal Reserve Bank of New York, asserted confidence in the Secured Overnight Financing Rate (“SOFR”) as the preferred alternative reference rate, despite the recent temporary spike in SOFR due to turmoil in the repo market. Williams expressed his confidence in the robustness of SOFR given that it is based on actual transactions (rather than judgement). He also requested market participants not to hope for the creation of another replacement reference rate and not to delay their transition away from LIBOR.
KPMG Insight: Banks should not use the SOFR temporary spike as an excuse to further delay their transition away from LIBOR. It is still questionable whether the spikes in the new risk-free rates will continue to happen, but it is certain that regulators do not consider it a limitation of the new risk-free rates as the fluctuations reflect rates on real transactions.
17 October 2019 NYFed
6. RBA warns ill-preparedness of market as end of LIBOR nears
Speaking at the 2019 ISDA Annual Australia Conference, the Assistant Governor of the Reserve Bank of Australia (“RBA”), Christopher Kent, warned the local market of its ill-preparedness for LIBOR transition as the end of LIBOR use nears. “If they haven't shifted new contracts to other reference rates, or inserted robust fallback provisions into existing contracts or existing arrangements, then those contracts will be tied up in very lengthy disputes and that's going to be very harmful to the institution in question and it's also potentially very harmful to the financial system more broadly,” Kent said.
KPMG Insight: Considering the significant size of the LIBOR-referenced market and wide-spread impact of LIBOR transition, financial institutions should start establishing project plans for LIBOR transition which should include setting up a governance framework, conducting an impact assessment, developing a detailed transition plan, and formulating a communication strategy.
23 October 2019 RBA
7. HKMA to conduct survey to assess AI’s progress in IBOR transition to ARRs
The Hong Kong Monetary Authority (“HKMA”) published a circular summarising the progress made by international authorities, standard-setting bodies and industry organisations to facilitate banks’ IBOR transition to alternative reference rates (“ARRs”). The HKMA also reiterated that HIBOR will not be discontinued while HONIA has been selected as the ARR by the Treasury Market Association (“TMA”). To collect information on authorised institutions (“AIs”) exposures referencing IBORs and monitor the progress made by AIs in their preparatory work for the transition, the HKMA will soon launch a survey and take follow up actions in view of the survey results of individual institutions.
KPMG Insight: The HKMA’s approach to propel banks to take proactive actions in IBOR transition, via the circular, echoes that of the global regulators, such as the FCA in UK (issuance of the Dear CEO Letter).
23 October 2019 HKMA
1. ISDA responds to EFRAG on benchmark reform
The International Swaps and Derivatives Association (“ISDA”) provided feedback on the European Financial Reporting Advisory Group’s (“EFRAG”) endorsed amendments to IFRS9, IAS 39, and IFRS 7 (collectively, the “Amendments”) published by the International Accounting Standard Board (“IASB”) on 26 September 2019. ISDA’s members agree with EGRAG’s assessment that the Amendments would be conducive to the European public good, they are likely to outweigh the costs involved in implementing the Amendments in the EU, and that the IASB amendment is not contrary to the principles and the criteria for endorsement set out in Regulation (EC) No 1606/2002.
KPMG Insight: The IASB guidance provides additional information for pre-LIBOR cessation accounting issues in respect of hedge accounting which could result in significant P&L impact. The feedback from ISDA is a positive indicator that the accounting amendments have been generally well-received by industry players.
3 October 2019 ISDA
2. ISDA comments on FASB’s Exposure Draft, Reference Rate Reform
ISDA supports the Financial Accounting Standard Board’s (“FASB”) proposals in the Exposure Draft to provide optional expedients and exceptions to applying certain U.S. generally accepted accounting principles (US GAAP) to contracts, hedging relationships, and other transactions that will be affected by reference rate reform.
KPMG Insight: While this update has an impact on financial institutions adopting US GAAP only, the industry should keep an eye on the latest developments of 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.
11 October 2019 ISDA
3. ISDA publishes report summarising results of benchmark fallback consultation on pre-cessation issues
The International Swaps and Derivatives Association (“ISDA”) published a report summarising the results of the benchmark fallback consultation on pre-cessation issues. While the respondents indicated that they would not continue referencing a covered IBOR in existing or new derivatives following from the supervisor it is no longer representative of the underlying market, no consensus has yet been reached on how to respond to such a statement in the context of fallbacks for derivatives. The majority of respondents (28.1%) opposed any implementation of a pre-cessation trigger in the context of fallbacks for derivative contracts.
KPMG Insight: Although it is not clear how the pre-cessation trigger would be activated, it is almost certain that there is a possibility of LIBOR being replaced by new risk free rates earlier than the end of 2021, hastening the need for banks to start their transitions as soon as possible.
21 October 2019 ISDA
Partner, Head of Financial
Financial Risk Management
Partner, Financial Risk Management
Financial Risk Management