SOFR impact in Asia

A closer look at SOFR and benchmark transition in Asia.

The US Federal Reserve announced the Secured Overnight Financing Rate (SOFR) as the new Risk Free Rate planned to replace USD LIBOR by 2021.

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The UK FCA reminded the financial industry it would no longer compel banks to do LIBOR submissions by 2021.

Central bankers and regulatory bodies around the world, including in Asia Pacific, are urging the industry participants to prepare for a transition to a future without LIBOR.

Several central banks have begun to look to Overnight Risk Free Rates as the alternative reference rates (ARR), such as London’s Sterling Overnight Interbank Average Rate (SONIA) and the EU’s ESTER (currently EONIA)

Stakeholders in Asia have taken note of SOFR development as the USD market has huge influence on Asian Rate markets. Participants globally are also looking to transition activities impacting cash securities products.

How Asian markets are preparing for the transition

The implications for the transition activities are on the radar in Asia, with three main areas of concern:

Fragmented adoption of benchmarks and managing different methodologies for different currencies across APAC

Liquidity and risk management in the face of transiting to new benchmarking initiatives
Defining and supporting the infrastructure needed to prepare participants for the transition

Sustainable liquidity needs in the transition phase

Fundamental concerns remain over fallback provisions, liquidity and term structure versus LIBOR swaps for short-term contracts.

Asian central banks will need to consider global developments whilst analyzing domestic markets. For example, Singapore is looking for a way to keep SOR (Swap Offered Rate) by combining SOFR, liquid FX Forward market trades and credit spread along a new term structure.

There is also growing issuance of contracts, bonds etc. are being issued using SOFR as the benchmark rate.

The depth and liquidity of the SOFR-backed market will need to increase in order to be sustainable as a future benchmark for dollar based contracts, and a migration of clearing house collateral rates to SOFR will likely assist this.

An April 2019 report from International Swap and Derivatives Association (ISDA) shed light on the market’s progression towards alternatives for other currency regions.

In Q1 2019, “IRD traded notional referencing alternative RFRs, including SOFR, SONIA, SARON and TONA, totaled $1.8 trillion and represented 2.5% of total IRD traded notional. The number of trades referencing alternative RFRs was 3,088, which accounted for 0.8% of total IRD trade count. TONA traded notional totaled $42.0 billion, including $1.0 billion of basis swaps.”

ISDA announced it will continue to monitor trading volumes of IRD referencing alternative RFRs and major interbank offered rates (IBORs),

and will report on trends as the market looks for alternatives.

ISDA’s fallback is a safety net. As there is a lot more on IBOR transition that requires attention.

Fragmented benchmark adoption

Different methodologies across both currencies and product may lead to market fragmentation, and complexities for both buy & sell side.

Solutions that work well for banks, for example, may be less suitable for insurance, the buy side, or corporates. For banks in particular, hedging typically poses a major concern yet less so for corporates – the conventional wisdom is that corporates/buy side do not like to be involved in

the OIS markets and prefer the certainty of cashflow projections on exiting IBOR methodologies.

Moving forward with infrastructure and advance planning

Regulators in Asia and beyond are actively encouraging readiness as well as collaboration amongst stakeholders. Many countries and regional markets are starting transition plans early due to the substantial technology and infrastructure changes that are needed, especially for larger books. For instance, the Australian Securities and Investments Commission (ASIC) has urged several Australian financial institutions to plan for LIBOR transition. In Hong Kong, HKMA Deputy CEO Howard Lee shared his insights into the reform of interest rate benchmarks.

With the various currencies and fallbacks in play, effective data modeling is even more crucial. Bloomberg offers state-of-the-art tools to help manage risk and assess liquidity, two

strategies that are essential for navigating the transition.

The Bloomberg Terminal, for instance, can run NPV, risk analysis (Greeks), and scenarios on a current portfolio as well as structure a “what if” portfolio of OIS-based swaps such as Fed funds or SOFR as potential replacements. Individual swaps can be structured and priced in the Swap Manager (SWPM <GO>) and added to a portfolio for analysis in MARS <GO>.

Bloomberg will continue to work with the industry to develop tools with an eye on enhancing capabilities for risk assessments.

Keep the conversation going

Both regulatory authorities and market participants face the same quandary: What does the market need in order to be prepared for the transition? A proactive approach is essential to minimize potential disruptions, with input from stakeholders all around.

An upcoming Bloomberg sponsored event in Hong Kong will bring regional authorities and stakeholders, such as the HKMA and the NY Federal Reserve, to move the discussion from basic level awareness towards planning for the next steps. Bloomberg remains committed to supporting the advancement of this conversation as 2021 approaches.

Global conglomerates should ensure their international headquarters stay in active communication with their regional headquarters in Asia. All stakeholders should continue to manage the risks associated with legacy positions, while keeping watch on transition policy discussions for their respective regions.

Learn more about how Asia is preparing for the future of benchmarks: