Planning for the future of benchmarks — with or without LIBOR

One of the most significant challenges facing the financial markets today.

From a global and Asia-centric perspective, benchmark reform and the future of LIBOR is one of the most significant challenges facing the financial markets today.

Bloomberg Professional Services

There is no guarantee that LIBOR will continue to exist after 2021, despite its current saturation of markets at an estimated level of $370 trillion.

Analysts are concerned that there are not enough transactions in the short-term interbank funding market to reliably calculate the benchmark, which is why regulators and leading experts gathered at this year’s International Swaps and Derivatives Association (ISDA) forum in Hong Kong, in partnership with Bloomberg, to discuss the future of LIBOR beyond 2021.

Interrelated impact on markets in Europe, Asia, and the U.S.

Replacing the IBORs in Europe and US could impact all levels of the markets, says Fiona Lui, Head of Bloomberg North Asia, but Asia, given

its substantial exposure to dollar funding, faces structural and institutional hurdles as a result of proposed benchmark changes. Some countries are considering retaining their credit-based or interest-rate benchmarks to work in parallel with the new risk-free rates benchmarks.

According to ISDA CEO Scott O’Malia, the transition from interbank offered rates (IBORs) to alternative risk-free rates (RFRs) will affect all parts of the financial market, from derivatives, bonds and loans to mortgages and deposits. The scale of exposure means market participant need to begin

preparing for benchmark reform now. With the UK FCA announcing that the regulator will not compel banks to make LIBOR submissions after the end of 2021, alternative RFRs need to be up and running before then, O’Malia says.

However, not every market is the same. In some jurisdictions, O’Malia said it’s possible that an existing IBOR may exist hand in hand with a new RFR. Under this so-called multi-rate regime, the IBORs might continue to be used as a reference rate for certain products and transactions -

for instance, corporate loans – while RFRs might be more appropriate for other instruments like derivatives. Asia, in particular, will essentially be the receiver of the transitions planned for Europe and the U.S., but it can navigate the transition better if regulators engage early enough to educate and help the industry prepare, and if there are opportunities to learn from how U.S. and E.U. companies make the shift. Panels like the ISDA-Bloomberg event can facilitate by bringing stakeholders together to give regulators and the industry an opportunity to engage directly.

In Hong Kong, HIBOR can be part of the solution in that it has been enhanced to assure long-term use with measures that include tightening regulatory and governance expectations but without compelling banks to contribute. Though with the ongoing monitoring of E.U. Benchmarks Regulation (BMR) development, the industry and regulators need to be prepared for market impact in case the situation changes course.

Credit-based benchmarks versus risk-free rates

Guy Debelle, Deputy Governor of the Reserve Bank of Australia (RBA), called for proactivity and attention to support for fallback provisions in his keynote speech at the forum. He suggested stakeholders consider whether risk-free benchmarks are more appropriate for some financial contracts than credit-based benchmarks.

Debelle pointed to the bank bill swap rate, or BBWS (the benchmark for the Australian dollar), as a well-advanced credit-based benchmark that can coexist with risk-free rates in a post-LIBOR world.

The U.S. Federal Reserve has also been working on alternative benchmarks, with the Secured Overnight Financing Rate (SOFR) emerging as the leading candidate. Joshua L. Frost, a Senior Vice-President from the New York Federal Reserve, observes that most users of LIBOR want interest rate exposure, not credit risk exposure, making SOFR stand out from the other benchmark

choices. SOFR’s its ability to reflect the cost of funding over longer periods of time makes this trait a benefit, and the benchmarks’ three-month moving average and the funding rate generally track each other well.

Looking Ahead

Viable alternatives for risk-free rates are under development right now, and the substantial amount of work for users of IBORs in Asia, both to amend contracts and update systems, requires ongoing dialogue like the exchange of ideas at this year’s ISDA Forum. A significant share of existing contracts have durations shorter than the end of 2021, and that most of them use 3-month rolling LIBOR. Frost is adamant that stakeholders must get ahead of benchmark changes and avoid waiting to start thinking about transition plans.

As for Asia, regulators and industry should continue the ongoing dialogue to navigate the upcoming global changes, assess impact and plan for what is most applicable and adaptable for the region.