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.
Further to the previous circular issued by the HKMA in July, the HKMA published its latest circular regarding the LIBOR reform and regulatory requirements to address the importance of customer protection and communication, in particular to retail banking customers. In order to reduce conduct risks and ensure that customer protection principles are duly upheld, AIs are expected to identify any potential impact of their products resulting from the LIBOR transition ahead of the product launch and ensure that associated risks to customers are assessed and managed. On the other hand, AIs are also expected to develop robust customer communication programmes at an early stage to promote customer awareness and understanding of the LIBOR reform, and provide sufficient training and updated market information to frontline staff to ensure that relevant staff are equipped with adequate knowledge to handle customer enquiries.
KPMG’s perspective: When considering the appropriate level of assessment and management of existing clients’ LIBOR-linked exposures, Banks should take into account the relevant impact on contract continuity, the risk of declining liquidity in the impacted products, and the need to engage with product issuers for the transition as suggested by the HKMA. The HKMA has also given a number of specific examples regarding customer communication programmes and outreach such as through newsletters, Frequently Asked Questions or animated videos, as well as setting up accessible channels for relevant enquiries and complaints. Banks are advised to look into all possible options proposed by the HKMA when preparing for the bank-wide communication plan between now and the end of 2021 to ensure regulatory requirements are carefully met.
21 October 2020 HKMA
2. HKMA urges local authorised institutions to take early action in adhering to the ISDA IBOR Fallbacks Protocol
In view of the IBOR Fallbacks Protocol recently published by ISDA on 23 October, the HKMA issued a circular to address their expectations for local authorised institutions to take early steps to adhere to the Protocol before its effective date on 25 January 2021, as well as planning proactive measures to encourage their counterparties to follow. In terms of the transition timeline, given the previous milestone set by the HKMA requesting AIs to include adequate fallback provisions in all newly issued LIBOR-linked contracts maturing after 2021 from 1 January 2021, the HKMA added that AIs may achieve this milestone for derivatives contracts within January 2021 considering the latest market development.
KPMG’s perspective: In response to the HKMA circular, Banks are strongly advised to take prompt action to adhere to the Protocol as a robust back-up for derivative contracts as well as fulfilling regulatory expectations. Banks should also update their bank-wide LIBOR transition plan taking into account the updated transition milestones announced by the HKMA regarding fallback development for derivatives contracts, and consider other transition roadmap recommended by global authorities (e.g. FSB) if necessary. Please refer to the below Section for details regarding the ISDA IBOR Fallback Protocol.
16 October 2020 HKMA
The ARRC published a latest memorandum to the Federal Reserve, FDIC and OCC concluding preliminary findings and recommendations with respect to potential regulatory considerations associated with the application of current and anticipated capital and liquidity requirements while the market transition away from the use of LIBOR. The memorandum addresses the capital and liquidity considerations that the ARRC has identified so far, including the preliminary assessment of market participants regarding the need to approach global regulators to request additional clarifying guidance regarding the capital and liquidity rules to facilitate the LIBOR transition. The memorandum may also be updated on a regular basis to reflect the ARRC’s latest findings or any potential clarifications on previously discussed topics
KPMG’s perspective: As the LIBOR transition may lead to a change in the liquidity, risk-weighted asset (“RWA”) or other treatment of impacted transactions to a certain extent under the applicable capital and liquidity rules, the memorandum intends to seek regulatory guidance and clarifications to avoid adverse impact to the macroprudential regulatory capital and liquidity requirements. The memorandum serves as a useful reference to market participants in order to better understand the international capital and liquidity standards while ensuring timely and smooth transition to ARR, as well as grasping the macro environment of capital and liquidity risk management and mitigation throughout the transition.
2 November 2020 ARRC
2. FASB issued a proposed accounting standards update on the scope refinement of the reference rate reform guidance
The FASB has released a proposed accounting standards update indicating scope refinements to the reference rate reform guidance (Topic 848) previously published in March with respect to the facilitation of the effects of the LIBOR reform on financial reporting. The latest proposed update clarifies that certain optional expedients and exceptions addressed in Topic 848 for contract modifications and hedge accounting would apply to contracts that are impacted by the discounting transition. The amendments are included to apprehend the incremental consequences of the proposed scope refinement and to address in particular the existing guidance to derivative instruments impacted by the transition.
KPMG’s perspective: In light of the broad population of derivative contracts impacted by the LIBOR transition, market participants have been assessing the relevant accounting implications and hedge accounting consequences resulting from the reform. The latest updates by the FASB could provide clearer guidance in response to the market concerns when considering the accounting implications of the LIBOR reform on derivative instruments in terms of margining, discounting, or contract price alignments, Banks could also refer to the updates while examining accounting implications and any necessary adjustments at the bank-wide level.
29 October 2020 FASB
3. ISDA published finalised IBOR Fallbacks Supplement and Protocol
ISDA has launched the finalised IBOR Fallbacks Supplement and IBOR Fallbacks Protocol subsequent to receiving a Positive Business Review Letter from the US Department of Justice, putting in place a global mechanism for the benchmark replacement of the current fallbacks in certain ISDA and non-ISDA agreements which will no longer be applicable upon the permanent cessation of LIBOR. The IBOR Fallbacks Supplement introduced updates to rate options in the 2006 ISDA Definitions to include new risk-free rate fallbacks for the 5 LIBOR currencies together with 8 other IBOR benchmarks, and will come into effect on 25 January 2021. Upon the effective date, the amended fallbacks will be implemented into new cleared and non-cleared derivatives transactions that reference ISDA’s standard definitions. The IBOR Fallbacks Protocol, on the other hand, enables market participants to incorporate the amendments into their legacy non-cleared derivative contracts with other counterparties that choose to adhere to the protocol, and will become effective on the same date as the IBOR Fallbacks Supplement. The Protocol will be open for public adherence from the date of the Launch.
KPMG’s perspective: The updated IBOR Fallbacks Supplement and Protocol provides an effective and robust mechanism for market participants to amend a large number of new and legacy derivative contracts involving many counterparties, thus playing a key part in ensuring an orderly transition from LIBOR to new risk-free rates. The new fallbacks are also expected to introduce fairness and transparency into the market by providing standard calculation approach for new replacement rates as industry reference. According to the HKMA circular issued on 16 October, AIs are expected to include adequate fallback provisions for derivatives contracts within January 2021. Banks should closely follow the HKMA timeline in planning their contract amendments to be in a position to offer new ARR products starting from January 2021.
23 October 2020 ISDA
4. FSB recommends widespread and early market adherence to the ISDA IBOR Fallbacks Protocol
In light of the IBOR Fallbacks Protocol and Supplement launched by ISDA on 23 October for LIBOR-linked derivative contracts, the FSB announced that broad and timely adherence to the Protocol is strongly encouraged for all financial and non-financial institutions impacted by the LIBOR transition, as taking a “tangible step” to avoid disruptions in covered derivatives contracts upon the LIBOR discontinuation or in the event LIBOR becomes non-representative. The FSB expressed that widespread adoption of the Protocol would be paramount to ensure its effectiveness in mitigating systemic risk followed by the LIBOR cessation. The FSB also suggested institutions who choose not to adhere to the Protocol to consider alternative steps to close out existing positions or appropriate bilateral amendments for new and existing derivatives contracts.
KPMG’s perspective: As expressed by the HKMA and the FSB, Market participants are expected to adopt the IBOR Fallback Protocol early in order to be well equipped to develop and launch ARR products including the new definitions. Banks can also take reference from the finalised Protocol and Supplement for market insights to assess other components such as pricing and valuation, accounting implications and back-office integration during the transition. Please refer to the above article for details regarding the IBOR Fallback Protocol.
9 October 2020 FSB
New Developments on RFR and Products
Bloomberg announced the execution of the first electronic SOFR versus Effective Federal Funds Rate (“EFFR”) basis swap compression trade on the Bloomberg SEF (“BSEF”). According to Bloomberg, the participants successfully completed the execution of a 10-year cleared swap unwind (equal and opposite to an original cleared position), through the application of request-for-quote on Bloomberg’s list trading tool (BOLT) to achieve compression of the original position at CME, where the swap was cleared.
12 November 2020 Bloomberg
2. CCP discount switch leads to record SOFR swap trading volumes
LCH and CME successfully completed the ‘big bang’ discounting switch from the Fed Funds Rate to SOFR which took place between 16 to 19 October as part of a major milestone in the LIBOR transition. Upon the switch, LCH and CME has replaced the risk-free rate used to value and pay interest on cash collateral for US$134 trillion of cleared USD swaps from the effective federal funds rate with SOFR, thus triggering record trading volume in the USD swaps market.
21 October 2020
3. OCBC Bank extended first SORA-based loan in energy sector to Sembcorp Industries
OCBC Bank announced the extension of another SORA-based corporate loan with the amount of SG$100 million to Sembcorp Financial Services Pte Ltd, a wholly-owned subsidiary of Sembcorp Industries. This marks the first SORA-referenced loan in the energy sector and another step by OCBC Bank in contributing to the development of the SORA market after its earlier collaboration with CapitaLand on the first SORA-based corporate loan in June and introducing the first SORA-based retail home loan in July.
20 October 2020 OCBC
4. Freddie Mac purchased first multifamily SOFR-based loan
Freddie Mac has purchased its first multifamily loan linked to SOFR through a deal arranged by CBRE. The transaction involves the refinancing of a US$20 million bridge loan for a multifamily project in Houston, Texas, and the loan was acquired by Freddie Mac in late September.
13 October 2020
5. BIS issued new working paper proposing alternative solutions to forward-looking term rates
BIS published a new working paper presenting alternative solutions for market participants, in particular in the loan market, whom are anticipating the development of forward-looking term rates in order to migrate cash products from LIBOR to new risk-free rates. The paper evaluated two practical ways in minimising the basis as well as suggesting the ideal approach to reduce the basis by using a shortened observation period when computing term rates based on historical overnight rate realisations.
8 October 2020 BIS
6. Standard Chartered Bank completed the first USD/HKD cross-currency swap in the Hong Kong market referencing HONIA and SOFR
Standard Chartered Bank announced the completion of the first US-Hong Kong dollar cross-currency basis swap referencing HONIA and SOFR in the market. In addition to that, it also announced the completion of the first USD/HKD cross currency basis swap referencing the three-month HIBOR and SOFR, thus providing additional hedging instruments to market participants as LIBOR-based instruments phase out at the end of 2021.
8 October 2020 SCB
7. ICE published Beta Version of GBP Swap Rate for SONIA swaps
ICE announced the launch of an initial beta version of its GBP ICE Swap Rate for the SONIA swaps market. According to the ICE announcement, IBA has started publishing daily indicative GBP SONIA ICE Swap Rate beta settings with tenors ranging from one to 30 years based on market feedback and consultation papers.
5 October 2020 ICE
KPMG’s perspective: In consideration of recent product development, a number of global milestones have been newly achieved as seen from increasing market shares in a wider range of financial products such as multifamily loan and cross-currency swaps with reference to new risk-free rates. New ARR-based product development has also been accomplished across different sectors (e.g. energy) apart from the finance sector. As for Hong Kong, the HONIA derivatives market had a significant breakthrough, 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.
On the other hand, in terms of pricing and curve development, the CCP discount switch encourages institutions to adopt the new discount curves in risk management function, IT infrastructure and process readiness. Market participants should accelerate the system and process enhancement including the construction, setup and support of new ARR discounting curves. The first SOFR-based compression trading offering also demonstrates more mature market development from prevailing vendors in supporting the transition more efficiently. Market participants should continue to keep track on the upcoming market updates from their vendors in terms of interest calculation and curve construction.