Meeting the needs for LIBOR transition

Operational hurdles, transparency around fallback provisions, and the extended vigil for market liquidity for IBOR alternatives, continue to confound market stakeholders.

Bloomberg Professional Services

More than half of the attendees at the Asia Pacific Benchmark Regulation and Migration Forum, co-hosted by Bloomberg and the International Swaps and Derivatives Association (ISDA), indicated that they expect their firms will still need a credit-based reference index similar to LIBOR after 2021. Regulators have cautioned the importance of not waiting for the trigger of fallbacks, but nearly half of the attendees said they need more clarity around the language of the provisions.

As the trading volume of IRDs referencing Secured Overnight Financing Rate (SOFR) remains comparatively small, “the build-up of transactions based on an alternative risk-free rate could take some time,” according to Howard Lee, Deputy Chief Executive Officer of the Hong Kong Monetary Authority (HKMA).

And for other IBORs, this could be an even longer and more challenging process.

While the market ponders this soon-to-be realized scenario, the need for awareness as well as transparency around data and liquidity assessment persists.

What would a post-2021 world look like?

Market disruption could potentially be mitigated by addressing interest rate swaps first and then tackling cross-currency derivatives.

Despite concerns, Scott O’Malia from ISDA said “the market is moving ahead of schedule” towards the implementation of SOFR as the alternative to USD LIBOR, with APAC regulators joining their

counterparts to further knowledge around alternatives and support existing benchmarks as feasible.

More clarity needed

One large area of uncertainty is a widespread lack of awareness regarding current and future state — leaving behind ambiguity around how to proceed for many.

Buy-side and sell-side leaders revealed that lending banks have not actively approached them to modify the fallback scenario for legacy positions. Vincent Chow, Group Treasurer of HK Electric Co., said there has been “only a handful of banks advising us on the development of the LIBOR transition.”

Generally, obstacles to bilateral negotiations are linked to who benefits or loses from a contract change. If one party is in the money and the other is not, there might be resistance to take action.

Market participants with larger back books tend to avoid taking a proactive approach to the fallback dilemma. “If you have billions and billions in notational referencing legacy rates, it is not that straightforward,” said Thijs Aaten of APG ASIA.

For these and other types of larger players, there are complex factors to balance. “Having very large directional legacy positions that we need to deal

with, I have a big worry about the value transfer when the fallbacks kick in,” says Aaten.

To date, much of the problem-solving activity around benchmark alternatives has been focused on the structural needs of the derivative market. Cash market also needs to be examined, and it is essential to consider how to bridge those gaps to avoid discrepancy.

For smaller participants with only a few contracts or less exposure, the challenge might be formidable, but not as complex. Nonetheless, all players need to consider how to ensure

transparency over the implications of any changes. Changing the reference rates, for example, continue to pose issues for hedge accounting.

Evolving toward alternatives

HONIA and HIBOR

In the case for Hong Kong, Lee announced that HONIA and HIBOR will co-exist in the market: despite HONIA's emerging status as a HIBOR alternative, HIBOR remains as a credible and reliable benchmark that has been in place for many years and is still widely recognized by market participants. The Treasury Markets Association (TMA) is thereby preparing to bolster HIBOR for compliance with international standards.

After evaluating feedback from an industry consultation on the technical refinements to HONIA, TMA also plans to promote, with industry collaboration, the development and trading of HONIA-based products as well as trading in the OIS market.

The case of BBSW

Like other regions, Australia’s key stakeholders have been working on domestic and international components of the transition. BBSW seems likely to survive as a regional benchmark alternative, unlike other global markets regarding LIBOR. There are enough transactions that underlies BBSW, the bank bill market, to be able to form a robust benchmark.

Systems and infrastructure

The Upcoming ISDA LIBOR Fallback serves as a "base case" for LIBOR transition, thus enabling participants to better plan for the 2021 LIBOR sunset" says Harry Lipman, Bloomberg’s Global Derivatives Product Manager.

"And we continue to add relevant data sets and enhance our analytics relevant to LIBOR Fallback in both the cash and derivatives markets,” he added.

Transparency and collaboration

Despite the work done to date, major challenges remain in key areas including: infrastructure, liquidity, structuring for benchmark alternatives, risk of market fragmentation, hedge accounting, and fallback provisions for legacy contracts.

The action starts now

Firms should start considering putting together cross-departmental working group to examine all the possible areas of the business that could be affected: Treasury, Investment, Trading, Corporate Planning, IT and infrastructure, Accounting – the list goes on.