Howard Lee of HKMA Speaks on Challenges in Benchmark Rate Transition

He discussed the inherent challenges in transition from LIBOR and highlighted that the transition process is challenging even for the deep USD market. He added that global banks should take the lead toward this transition, although smaller banks should not just wait and see. Though there may still be uncertainties for the transition, all banks and corporations should, as a fundamental first step, keep themselves updated on the latest developments and understand what aspects of their business would be affected. Undertaking detailed risk assessment and formulating an action plan would be next. Client education is another vital task. Banks should begin outreach to their clients and educate them about the benchmark transition early. This could help to minimize misunderstanding and costly litigation in the future. He then discussed the work being done in Hong Kong in this area.

While discussing the steps taken to raise market awareness in Hong Kong, Mr. Lee said that the Treasury Markets Association (TMA) has been working with bank representatives on benchmark reform for many years and has set up a Working Group to engage a wide spectrum of stakeholders. The Working Group is looking at issues like the implications on accounting and the transition of cash products. It will further engage stakeholders to explore means of encouraging the adoption of alternative reference rates in their day-to-day transactions and business activities. HKMA supervisors have also been actively engaging banks. In March, HKMA had issued two circulars to banks in Hong Kong. The first circular reminded banks to assess risks and prepare for the necessary transition. The second circular clarified that amendments to the existing derivatives contracts, which are made to give effect to interest rate benchmark reform, will not be considered new contracts from the perspective of the HKMA margin requirements. This removes one of the uncertainties about the transition. 

As financial institutions in Hong Kong are gathering pace in their preparation for the LIBOR transition, progress is being made in identifying an alternative reference rate for HIBOR, added Mr. Lee. HKMA conducted a feasibility study of compiling HKD term rates based on actual wholesale funding transactions by major banks. The results showed that while transaction-based wholesale term funding rates generally followed term HIBORs, they exhibited a high level of daily volatility, which made them an impractical substitute for term HIBORs. More recently, TMA proposed adopting the Hong Kong Dollar Overnight Index Average (HONIA) as the alternative reference rate for HIBOR. Similar to many alternate reference rates chosen in other currency areas, HONIA is an overnight interbank funding rate. While lacking a term structure on its own, this reference rate is robust and based purely on transaction data.

In early May, TMA completed a consultation with the industry on several technical refinements to HONIA and is now reviewing the feedback received. When the enhancements are done, TMA will work with the industry to promote development and trading of HONIA-based financial products. While HONIA serves as an alternative to HIBOR, there is no plan to discontinue HIBOR. HIBOR has been in place for many years and is still widely recognized by market participants as a credible and reliable benchmark. Similar to a few other jurisdictions in the region, Hong Kong will adopt a multiple-rate approach. HONIA and HIBOR will co-exist in the market and market participants are free to choose between them. It may be true that HIBOR will last for some more time. Nevertheless, the transition to SOFR in the USD space could gradually lead to changes in market practices and to conventions that may eventually shift market preference for interest rate benchmarks. Therefore, if more HONIA-based products can be introduced in the market going forward, it would help reduce any market impact in case HIBOR has to discontinue one day, owing to changes in market circumstances.

Related Link: Speech

Keywords: International, Asia Pacific, Hong Kong, Banking, Insurance, Securities, HONIA, Interest Rate Benchmarks, LIBOR, Treasury Markets Association, HKMA, BIS