April 12, 2019

At the ISDA 34th Annual General Meeting in Hong Kong, Guy Debelle, the Deputy Governor of the Reserve Bank of Australia, provided an update on the progress with benchmark reform internationally and highlighted the key issues and developments in Asia Pacific. He first outlined the progress toward benchmark reforms in the U.S., UK, and EU, before moving on to discuss the status of these reforms in Asia Pacific. Also discussed were the key issues related to transitioning to alternative risk-free rates, putting in place robust fallback provisions, and the co-existence of credit-based benchmarks with the risk-free rates in Asia Pacific.

Mr. Debelle said that it has been almost two years since Andrew Bailey announced that FCA would no longer use its powers to sustain LIBOR beyond 2021. Since that time, preparing for the end of LIBOR has been a key challenge globally. The Official Sector Steering Group (OSSG) of FSB has been monitoring progress on the transition and ensuring that contracts referencing LIBOR include robust fallback provisions. The transition from LIBOR to alternative risk-free rates (RFRs) is accelerating internationally. RFRs have been identified for all the LIBOR currencies by national working groups involving the private sector and regulators. The rates chosen are overnight RFRs, either measured from transactions in inter-bank unsecured lending markets or repo markets. It has now been a year since FED started publishing the Secured Overnight Financing Rate (SOFR) and since BoE implemented reforms to Sterling Overnight Index Average (SONIA). Recently, ECB also announced that it will launch Euro Short-Term Rate (€STR) at the start of October. The currency most progressed on developing a term RFR is sterling. However, the recent consultation by the UK working group found that there would need to be a "step change" in activity in derivatives markets for a term SONIA rate to be sufficiently robust.

He added that market participants preparing for the LIBOR transition are encouraged to work on using overnight RFRs rather than waiting for the development of term RFRs. Furthermore, FSB has made it clear that derivatives markets will largely need to transition to the overnight RFRs to ensure financial stability. Derivatives represent the largest exposure to LIBOR and only transitioning to the overnight RFRs can address the core weakness of LIBOR, which is the absence of deep and liquid markets to underpin these benchmarks. In Asia Pacific, considerable work is being undertaken to strengthen local benchmarks and prepare for the LIBOR transition. Australia, Hong Kong, Japan, and Singapore are all represented on the FSB OSSG and Australia is also working within regional forums to highlight benchmark reform issues.

Australia has taken a "multiple rate approach," said Mr. Debelle. The credit-based benchmark the Bank Bill Swap Rate, or BBSW, has been strengthened and co-exists alongside the cash rate, which is the RFR for the Australian dollar. BBSW can continue to exist even after LIBOR ends. However, as markets transition from referencing LIBOR to RFRs, there may be some corresponding migration away from BBSW toward the cash rate. This will depend on how international markets for products such as cross-currency basis swaps end up transitioning away from LIBOR. Good progress is being made on developing new market conventions for trading cross-currency basis swaps, referencing RFRs, or combinations of RFRs and IBORs, to give market participants the choice. Regulators in the region are also seeking to strengthen the contractual fallbacks for their benchmarks. The Australian and Japanese benchmarks (BBSW, JPY LIBOR, and TIBOR) were included in the ISDA consultation last year while the Hong Kong and Singaporean benchmarks (HIBOR and SOR) are expected to be considered in the next round of the ISDA consultation. Once ISDA finalizes these fallbacks, all users of benchmarks in the region are strongly encouraged to adopt them. 

As per Mr. Debelle, one issue that has been generating quite a bit of angst in the region is the impact of EU Benchmarks Regulation (BMR). Under the BMR, EU supervised entities—including banks and central counterparties—can only use benchmarks that are registered in EU. To achieve this status, benchmarks administered outside EU would need to be in a jurisdiction with a legal framework judged by EU to be "equivalent" to the BMR, or would need to substantially comply with the BMR. The EU had set a deadline of January 01, 2020, but has recently announced a two-year extension. This is a welcome development and provides administrators in the region with valuable additional time to comply with the requirements of the BMR. In addition,  EU has recently issued draft decisions recognizing the Australian and Singaporean regulatory regimes as equivalent to the BMR. This means that benchmarks such as BBSW and SOR can continue to be used in the EU after January 01, 2022.

In conclusion, he reiterated that the end of LIBOR is approaching and market participants should continue to prepare for this by transitioning to alternative RFRs. He also highlighted that most jurisdictions in Asia Pacific have chosen to strengthen their credit-based benchmarks. This includes Australia, where BBSW remains robust. Credit-based benchmarks can co-exist alongside risk-free rates when they are supported by liquid underlying markets. Users can then choose the benchmark that is most appropriate for their circumstances.

 

Related Link: Speech (PDF)

 

Keywords: International, Asia Pacific, EU, Australia, Banking, Securities, LIBOR, Risk-Free Rates, Interest Rate Benchmarks, Derivatives, SONIA, SOFR, Benchmarks Regulation, BIS

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