1.HKMA circulated survey on reform of interest rate benchmarks
On 18 November 2019, the Hong Kong Monetary Authority (HKMA) circulated a survey on reform of interest rate benchmarks to collate information on the progress made to date by Authorized Institutions' (“AIs”) in their preparation to transition to alternative reference rates. The survey’s primary focus is to gather information on governance instituted by AIs to manage the transition, AIs transition plan and strategy, statistics related to outstanding and new contracts and lastly whether the new contracts contain adequate fall back provisions. AIs are required to respond to this survey by 23 December 2019.
KPMG Insight: KPMG survey revealed that the banks were relatively advanced in carrying out a preliminary impact assessment of the products which were directly referencing LIBOR, however found it challenging to identify exposures indirectly referenced to LIBOR and their fall back provisions in order to determine the effective remediation approach. It will be interesting to see whether AIs are able to report the required statistics on different LIBOR exposures to the definite precision.
18 November 2019 HKMA
2.Agencies propose rule to amend swap margin rules
The Federal Reserve Board, the Farm Credit Administration, Federal Deposit Insurance Corporation, Federal Housing Finance Agency, and the Office of the Comptroller of the Currency announced a proposal to change the swap margin rules to facilitate the implementation of prudent risk management strategies at certain banks and swap entities. To aid in the transition away from LIBOR, the agencies proposed to allow certain technical amendments to legacy swaps without altering their status under the swap margin rules.
KPMG Insight: The suggested changes in relation to margin rules in the proposal will impact LIBOR linked swaps; Financial Institutions should not confuse these changes with the initial margin requirements for in-scope uncleared OTC Derivatives products stipulated by the CFTC.
28 October 2019 Fed
3.Statement Requesting Public Comment on a Proposed Publication of SOFR Averages and a SOFR Index
The Federal Reserve Bank of New York (Fed), in cooperation with the Treasury Department Office of Financial Research (OFR), is proposing to publish daily three compounded averages of the SOFR with tenors of 30-, 90-, and 180- calendar days. The use of compounding would also align with ISDA’s methodology for use of overnight rates in swap contracts. The Fed plans to initiate publication of these averages in the first half of 2020. In addition, the Fed is also proposing to publish daily a SOFR index that would allow the calculation of compounded average rates over custom time periods.
KPMG Insight: Financial Institutions to consider the proposed methodology published by the Fed which aligns to the ISDA methodology for overnight rates in swap contracts in its implementation of the new ARR. Financial institutions will need to also consider whether the proposed calculation methodology, including the compounding approach, is appropriate for calculating the averages and index.
4 November 2019 Fed
4.SEC: Pending transition presents risks and requests for market comments
In his remarks to the SEC Fixed Income Market Structure Advisory Committee, Securities and Exchange Commission (SEC) Chairman Jon Clayton acknowledged that there is substantial work pending to avoid frictions that can harm investors. The issue is the fundamental difference between the composition of USD LIBOR and SOFR which can make a like-for-like mapping of a LIBOR product to a SOFR product challenging.
KPMG Insight: Firms to identify products which would be impacted should a like-for-like mapping to a LIBOR product be unavailable and begin to plan for the implications across valuations, clients, systems, accounting, etc.
4 November 2019 SEC
5.Working group on euro risk-free rates issues recommendations to address accounting impact of euro risk-free rates transition
The working group on euro risk-free rates published a report describing the overall consequences for financial accounting and potential issues that may arise, especially concerning hedge accounting. Recommendations have also been provided in the report covering three areas – the impact of transition from EONIA to €STR, fallbacks for EURIBOR and hedge accounting, as well as general accounting and financial reporting.
KPMG Insight: The implications and recommendations pointed out by the working group to financial institutions echo those identified by the FASB in its proposed Accounting Standards Update and the IASB’s exposure draft in relation to IFRS 9 and IAS 39.
5 November 2019 ECB
6.Working group on euro risk-free rates recommends fallback arrangements for users of €STR
The private sector working group on euro risk-free rates published a report explaining the two options considered for a fallback arrangement for the use of €STR, the measures that can be taken by the European Central Bank (ECB) as part of the review of €STR methodology and recommended fallback provisions provided by the working group in the EONIA to €STR Legal Action Plan.
KPMG Insight: The industry-led working group for which the ECB is a secretariat is perhaps the first to recommend fallback arrangements for a recently established alternative reference rate to EONIA, i.e. €STR. Market participants should consider fallback measures for €STR taking into consideration review of the €STR methodology, as well as policies and procedures to be followed in the event of €STR cessation and the fallback provisions provided by the working group.
12 November 2019 ECB
7.FCA: Treating customers fairly when replacing LIBOR
The Financial Conduct Authority (FCA) stressed that firms need to ensure they have taken reasonable steps to treat customers fairly and the information provided is not misleading. In particular, the FCA pointed out firms’ responsibility in ensuring replacement rate is fair, effectively communicating the fallback provisions and their methodology to clients, offering products that meet customers’ needs and in engaging with the customers in good time to allow them to make informed decisions. Amidst the guidance, the FCA also pressed firms to extend their Senior Manager arrangements to cover LIBOR risk.
KPMG Insight: In Hong Kong, banks should start identifying the accountable and responsible Manager-In-Charge (MIC) and embedding oversight of LIBOR transition in their responsibilities. Additionally, they should carefully assess the implications of passing on costs, resulting from LIBOR transition to alternative RFRs, to customers and how such treatment would render the bank acting in the best interests of clients.
19 November 2019 FCA
8.FCA provides next steps in transition from LIBOR
At the Risk.net LIBOR Summit in London, Edwin Schooling Latter, Director of Markets and Wholesale Policy at the Financial Conduct Authority (FCA), laid out next steps in reducing risks from continued use of the LIBOR benchmark. One such step was encouraging market makers to make SONIA the market convention from Q1 2020, given that the liquidity and infrastructure to support SONIA swaps are already in place. The other key messages reiterated the conduct risk arising from striking new LIBOR referenced contracts (maturing beyond end-2021) and highlighted the developments made in fallback language by the ARRC and ISDA with respect to cash market and derivative contracts, respectively.
KPMG Insight: In the UK, the market had seen its first LIBOR to SONIA loan conversion; this is something market participants in Hong Kong may want to start considering for their LIBOR transition. Firms should also consider adopting pre-cessation trigger in derivatives to help resolve the hedging issue posed by new LIBOR cessation triggers or existing ISDA language.
21 November 2019 FCA
1.ISDA: Interest Rate Benchmarks Review
The International Swaps and Derivatives Association (ISDA) analysis of trading volumes of Interest Rate Derivatives (IRD) traded in the United States of America, referencing SOFR and other selected alternative risk-free rates (RFRs), SONIA swaps represented 92.7% of the transaction referencing alternatives RFRs, while SOFR swaps accounted for 4.3% of IRD traded notional referencing alternative RFRs (which include SOFR, SONIA, SARON and TONA) in third quarter of 2019.
KPMG Insight: The increase in SOFR and SONIA referenced transactions is expected given their familiarity across the participants and the already established liquidity infrastructure. It is worth noting that the market continues to trade in IRD contracts referencing LIBOR maturing after 2022. As of Q3 2019 there was approx. US$30 trillion of IRD notional value in USD LIBOR, GBP LIBOR and EUR LIBOR maturing after 2022.
28 October 2019 ISDA
2.FASB approves finalisation of guidance to assist in transition away from interbank offered rates to new reference rates
The Financial Accounting Standards Board (FASB) approved the Accounting Standards Update (ASU) to provide temporary, optional guidance to ease the potential burden in accounting for, or recognizing the effects of, reference rate reform on financial reporting. The final ASU is expected to be issued in early 2020.
KPMG Insight: The ASU will offer relief to financial institutions only if they spend the current time period identifying contract modifications which meet the criteria listed out in the ASU.
13 November 2019 FASB
3.FSB letter to ISDA on pre-cessation triggers
The Financial Stability Board (FSB) in its letter to the International Swaps and Derivatives Association (ISDA) encouraged the addition of a “pre-cessation” trigger alongside the cessation trigger as standard language in the definitions for new derivatives and in a single protocol, without embedded optionality, for outstanding derivative contracts referencing key Interbank Offered Rates to reduce systemic risk and market fragmentation.
KPMG Insight: Incorporating pre-cessation triggers in new derivatives accounts for the possibility of fallbacks getting triggered prior to Dec 2021. Firms should also consider adopting pre-cessation triggers in cash products to align cash and derivative pre-cessation triggers and avoid hedging mismatches.
15 November 2019 FSB
4.ARRC Releases Recommended Fallback Language for Residential Adjustable-Rate Mortgages
The Alternative Reference Rates Committee (ARRC) released recommended contractual fallback language for new U.S. dollar (USD) denominated closed-end, residential adjustable-rate mortgages (ARMs) for voluntary use by market participants in the event that LIBOR is no longer available. In addition to the ARMs provisions, the ARRC issued recommended fallback language for bilateral business loans, floating rate notes, securitizations, and syndicated loans.
KPMG Insight: Although USD mortgage loans are not common in Hong Kong, in general, Financial Institutions should start educating market participants which are affected by the change on the provisions of fallback to avoid client complaints and litigation costs at a later stage.
15 November 2019 ARRC
5.ISDA publishes results of consultation on final parameters for benchmark fallback adjustments
The International Swaps and Derivatives Association (ISDA) published a report covering technical issues related to fallbacks for derivative contracts that reference key currencies. Market responses revealed that 61% of the respondents preferred a calculation of a spread adjustment based on a historical median over a five-year lookback period for reasons that the median methodology is simple, transparent, and a more stable method, is less sensitive to outliers, and would not require complicated data treatments. As the next step, ISDA will make the relevant amendments to the 2006 ISDA Definitions to incorporate fallbacks with these adjustments for new IBOR trades.
KPMG Insight: It is recommended that Financial Institutions follow developments within the industry and strategise on implementing standardised language and fallback adjustments in the contracts expiring beyond the end of 2021.
15 November 2019 ISDA
6.ARRC Releases Appendix to SOFR Floating Rate Notes Conventions Matrix
The Alternative Reference Rates Committee (ARRC) published a handy Appendix to the previously issued Conventions Matrix identifying considerations for market participants interested in using SOFR in new issuances. These considerations include term sheets with key provisions, including the specific differences between certain conventions, and recommended fallback language for SOFR-based floating rate notes.
KPMG Insight: The SOFR Floating Rates Notes Comparison Chart is a useful example putting into context the conventions which can impact cash flows before an interest payment is due. Financial Institutions may refer to this chart to get a view of cash flow certainty for other alternative RFRs, as they are based on overnight (secured or unsecured) transactions.
21 November 2019 ARRC
Financial Risk Management
Partner, Head of Financial
Financial Risk Management