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. HKMA releases the second interest rate benchmarks reform results and transition milestones
The Hong Kong Monetary Authority (HKMA) releases the latest results of the Survey on Reform of Interest Rate Benchmarks and the key milestones that authorized institutions should endeavour to achieve in transition to alternative reference rates (ARRs). The survey results showed an increase in LIBOR-linked exposures maturing beyond 2021 and having no adequate fall-back provisions. In addition, the proportion of AIs which had developed a bank-wide transition plan increased by 23% to 61%.
The HKMA also announced the following transition milestones which AIs are expected to achieve:
I. AIs should be in a position to offer products referencing the ARRs to LIBOR from 1 January 2021;
II. Adequate fall-back provisions should be included in all newly issued LIBOR-linked contracts that will mature after 2021 from 1 January 2021; and
III. AIs should cease to issue new LIBOR-linked products that will mature after 2021 by 30 June 2021.
KPMG Insight: Over the past few weeks, there has been significantly more activities and discussions on LIBOR transition among banks in Hong Kong which is largely driven by the HKMA. While it is promising to see a significant increase in the number banks developed a bank-wide transition plan, we expect banks to revisit their transition plan to align their key milestones with the HKMA’s timeline. Out of the three milestones identified by the HKMA, a number of banks find it most challenging to get the systems and processes ready to offer new products referencing the ARRs by 1 January 2021. Given the lengthy process of changing systems and processes, banks should prioritize this task and initiate the conversation with third-party vendors and internal technology department as soon as practicable.
2. BoE confirms it will publish the SONIA Compounded Index in early August
The Bank of England (BoE) confirmed it will use the methodology outlined in its discussion paper to produce the SONIA Compounded Index. The aim is to simplify the calculation of compounded interest rates. It is equivalent to a series of daily data which represents returns from a rolling unit of investment earning compound interest each day at the SONIA rate. Furthermore, the BoE provides an example of calculating compounded SONIA rates in the Appendix in its paper.
KPMG Insight: Given the unanimous feedback from market participants on the methodology for the SONIA Compounded Index, firms should actively prepare for the publication of the rate in August. The BoE noted it would not produce SONIA period averages as a number of market participants noted these would not be used in financial contracts.
6 July 2020 BoE
3 .SEC Examination Initiative on LIBOR Transition Preparedness
In a note on the US Securities and Exchange Commission (SEC) alert, the Office of Compliance Inspections and Examinations (“OCIE”) intends to engage registrants through examinations to assess their readiness for the transition to RFRs and discontinuation of LIBOR. Registrants will be assessed against business activities, operations, services and investors. In addition, the OCIE will review the plans developed by registrants as well as the steps taken to prepare for the LIBOR discontinuation.
KPMG Insight: Impacted SEC registrants should prepare for the OCIE examinations, some of the areas of focus include but are not limited to the following:
- Organisational structures and business lines, in particular the areas impacted by the LIBOR transition
- Governance committees responsible for overseeing the LIBOR transition, including evidence such as terms of reference and meeting minutes
- Analysis of the impacted contracts and corresponding remediation plans
- Risk matrices or risk inventories which outline the LIBOR transition exposure or vulnerabilities
- Guidance provided to the firms’ employees on the provision of advice to issuers of new LIBOR-linked instruments.
23 June 2020 SEC
4. FCA statement on planned amendments to the Benchmark Regulation
The Financial Conduct Authority (FCA) supported the HM Treasury’s announcement to bring forward the legislation to amend the Benchmark Regulations (BMR). The legislation would allow the FCA to protect firms that cannot amend their contracts through managing and directing an orderly wind-down of critical benchmarks such as LIBOR. The administrator of LIBOR will be directed to change its methodology used to compile the benchmark to protect consumers and market integrity.
KPMG Insight: The FCA will seek views from financial institutions on possible methodology changes based on RFRs and the various methods in calculating an additional fixed credit spread that reflects the difference between LIBOR and RFRs, to assist with defining its policy outlining its approach.
23 June 2020 FCA
5. Bank of Canada becomes the administrator for CORRA
In June 2020, the Bank of Canada (BOC) became the administrator of the Canadian Overnight Repo Rate Average (CORRA). The Bank published its first rate which is calculated using an improved methodology to ensure it is:
- Robust, reliable and representative of the secured overnight funding rate
- Considered the key Canadian benchmark rate and hence readily available for use globally
- Aligned with the Principles for Financial Benchmarks set out by the International Organisation of Securities Commissions.
15 June 2020 BOC
1. FMSB publishes spotlight review on ‘LIBOR transition: Case studies for navigating conduct risk’
The FICC Markets Standard Board published a Spotlight Review on LIBOR transition in June 2020. The paper provides practical case studies to support firms address risks that may arise with respect to market fairness and effectiveness as the market moves to risk-free rates. In particular, the paper addresses the risks across six key themes.
KPMG Insight: The Spotlight Review provides considerations for firms across the six risk themes as follows:
- Risk identification: Firms should have risk taxonomy in place to identify the conduct risks that may occur in market transactions and consider the risks arising from the LIBOR transition and how these will be incorporated into its overall risk taxonomy.
- Governance: The outputs of the firms’ risk assessment process should be provided to Senior Management to assist in decision-making of the firms’ overall strategy for managing conduct risks arising from the LIBOR transition.
- Communicating with customers: Firms’ should duly consider communications made to client with respect to the cessation of LIBOR to ensure they are easily understood.
- Conflicts of interest: Firms should take appropriate measures in managing conflicts which may arise from the LIBOR transition. In particular, the FCA has identified potential conflicts arising where fund managers change performance benchmarks. Firms should ensure this does not misrepresent benchmark performance.
- Treating customers fairly: Firms should ensure products offered to clients continue to operate effectively based on the fallback language. In addition, firms should also ensure customers are treated fairly when choosing reference rates.
- Market conduct: Firms should consider any new cases of market misconduct arising from the LIBOR transition and where necessary enhance surveillance and awareness across the first and second lines of defence.
11 June 2020 FMSB
2. CFPB releases an updated Consumer Handbook on Adjustable Rate Mortgages (CHARM)
In June 2020, the Consumer Financial Protection Bureau (CFPB) released an updated Consumer Handbook on Adjustable Rate Mortgages (CHARM) to help consumers better understand adjustable rate mortgage loan products. In addition, the Bureau issued proposed rule amendments to Regulation Z to address the discontinuation of LIBOR which includes examples of replacement indices that meet Regulation Z standards. Lastly, the CFPB issued FAQs to provide guidance on the implementation considerations for LIBOR and the requirements for adjustable-rate mortgaging servicing notices, adjustable-rate mortgage and home equities lines of credit (HELOC) origination disclosures.
KPMG Insight: Financial institutions should assess the proposal made by the CFPB on open-end and close-end provisions. In particular, for open-ended provisions the Bureau is proposing to restrict index changes, requiring change in notices, and addressing the application of credit card evaluations. Firms are requested to provide comments on the Bureau’s proposed rule by August 4, 2020.
04 June 2020 CFPB
Head of Financial
Financial Risk Management
Financial Risk Management
Financial Risk Management
Financial Risk Management