The LIBOR Transition Continues, but Is Asia Ready?
Terence Mark and Paul Noring
Asian countries are behind the curve when it comes to selecting, preparing for and implementing new benchmarks in the LIBOR transition.
The much-talked-about LIBOR transition—a move away from a key interest-rate benchmark that has been universally understood and accepted for decades—has been delayed, with the demise of some USD LIBOR rates pushed from the end of this year to mid-2023.
Many US banks welcomed the delay when it was announced in January, but other regions, notably Asia, are behind in terms of selecting, preparing for and implementing new benchmarks. The stakes are high, as LIBOR (the London Inter-Bank Offered Rate) is the underlying benchmark across five major currencies and underpins bonds, derivative contracts, loans and other financial products estimated at more than $300 trillion.
LIBOR is actually 35 separate interest-rate benchmarks across global markets, and the timing for phasing out those benchmarks, including those most widely used in USD, remains uncertain. In Asia, Japan (a LIBOR currency), Hong Kong and China are taking different approaches, with varying levels of success in transitioning to new a benchmark (or benchmarks) and implementing their use across a diverse range of financial products. Smaller markets such as Korea, Singapore and Taiwan are facing similar levels of uncertainty.
With so much on the line for global financial markets, we highlight the differences in preparation across Asia, with some context about how the US is preparing, what can—and should—happen for those markets to make a successful transition and risks inherent in further delays.
What Is Happening in the US with the LIBOR Transition
In the USD market there is an ongoing debate whether LIBOR’s best replacement is the Federal Reserve’s Secured Overnight Financing Rate (SOFR) or AMERIBOR, a benchmark from the American Financial Exchange which is considered more stable and also incorporates a credit-spread component, unlike SOFR.
Zions Bancorporation, a large regional bank, was the first to announce that it would transition the majority of its lending to AMERIBOR. Other providers have begun to roll out credit-sensitive alternatives, such as Bloomberg via its Short-Term Bank Yield Index (BSBY) and ICE Benchmark Administration via its Bank Yield Index. Bank of America recently issued a $1 billion floating rate note tied to the BSBY.
Mid-size and smaller US banks have been vocal in their views that the risk-free SOFR rate is not the best alternative for their lending portfolios. In November 2020, the US regulators formally acknowledged that rates other than SOFR could be used. They also were explicit that new LIBOR denominated contracts should cease by December 31, 2021, thereby providing 18 months to transition tough legacy deals that do not have fallback provisions.
State governments in the US also are getting into the game: the New York State Legislature passed LIBOR transition legislation in March which provides safe harbors for the transition of tough legacy contracts. Similar legislation is moving forward at the national level. Therefore, no one should be under any illusions that change isn’t coming soon, despite past delays.
How Asia Compares
Asia has variations in local markets, however, reasons for delays in the selection of a replacement for LIBOR share common themes. These include implications of using a backward-looking risk-free rate (RFR) rather than a forward-looking risky rate, concerns about the ability to calculate and verify any new benchmark, a potential “wealth transfer” as RFRs are typically lower than risky rates and an inability to hedge existing positions due to illiquidity in basis markets.
Further, there is a lack of clarity relating to the proposed use of synthetic LIBOR for transactions without fallback provisions or those deemed to be “tough legacy”.
The Japanese financial market is Asia’s largest, and yen is a LIBOR currency. But market participants have been slow to transition from LIBOR to TONA (Tokyo overnight average) which is an RFR. This lack of urgency is evidenced by volume statistics that have TONA swap transactions representing less than 3 percent of the total measured by trade volume.
Although Japanese regulators have weighed in by stating actions necessary for the transition to occur, there is still a lack of transparency on issues such as fallback language and basis adjustments. Further, TIBOR, which is widely used for domestic borrowing and lending transactions, will continue to exist in parallel with TONA. Japanese society values compromise and consensus, and for now, the market is seeking to achieve this at its own pace.
The Hong Kong dollar is not a natural LIBOR currency, so there is less urgency locally to convert to new benchmarks. However, a smooth transition away from LIBOR will be critical for Hong Kong to maintain its status as a global financial hub. Hong Kong’s banking regulator, HKMA (Hong Kong Monetary Authority), recently announced a six-month delay in implementing regulations requiring banks to cease using LIBOR as a benchmark for financial products maturing beyond year-end 2021, which would appear to align Hong Kong with the US. For local currency transactions, HIBOR, set by Hong Kong banks, will continue to exist in parallel with HONIA (Hong Kong overnight index average), its alternative reference rate.
Other Asian countries have moved to adopt alternatives to LIBOR with varying success. China, which has used many benchmarks for borrowing and lending, is adopting a local repo rate (DR) as its alternative to LIBOR while maintaining the use of SHIBOR. Singapore is retaining locally fixed SIBOR and adopting SORA (Singapore overnight average rate) as its alternative to LIBOR. South Korea’s use of KORIBOR looks set to continue, as no alternative has been officially selected.
Time (Still) Running Out on LIBOR
LIBOR ceasing to be used as a global benchmark is a certainty, but selecting and implementing alternative benchmarks is rife with uncertainty and risk. Markets which fail to quickly adapt will be unable to attract the liquidity necessary to sustain viability.
Avoiding that failure is the responsibility of governments, regulators and market participants—and that last group can and should move quickly to test the market and some of these new potential benchmarks with initial transactions. Executing actual contracts and working through the complexities is the best way to build competencies and develop new internal operational processes while helping establish reference rates.
Boards, CFOs and treasurers should push their transition and lending teams to do these prototype transactions. The strategy of simply waiting to see how market practices unfold before making any moves is problematic when it comes to the enormity of this reference rate transition. Organizational innovation and adaptability to the new reference rate paradigm require trial and error now and not next year.
Failing to take these kinds of actions will negatively impact credit ratings and financing cost for businesses and individuals, ultimately impacting economies at a national level. It also will result in litigation by those deemed to have been harmed by decisions made or not made by governments and regulators.
For global markets to prosper after the eventual transition, participants will demand, among other things, liquidity, the ability to transact and hedge across a full-term structure and agreement on how they will deal with legacy transactions.