Li Renn Tsai compares progress in Asia’s main trading hubs, warning of a logjam of transition-related operational work that will pile up towards year-end.
The clock is ticking for LIBOR. Nearly a decade after the benchmark lending rate was hit by a high-profile fixing scandal, the financial industry is moving ever closer to the transition date for a range of replacement rates, as transaction-based methodologies are taking centre stage. At the beginning of 2021, we see different market participants at different levels of preparedness for a fundamental shift that will affect everything from interest rate swaps to syndicated loans and credit cards.
Those who think that doing nothing is an option, or that the pandemic has delayed the need to prepare for the new rates, are making a mistake that could leave them unprepared further down the line. In early March, the ICE Benchmark Administration (IBA), the body that manages LIBOR, said that it would stop publishing most LIBOR rates at the end of 2021, with a few USD rates staying in action until June 2023. This official announcement is the final word on LIBOR cessation timing, and it presents a definite deadline for institutions to work towards.
In Asia, the situation is complicated, with each of its financial centres implementing their own risk-free rates. And it is a similar situation to what we are seeing in Europe and the US, as most businesses are at an early stage of transition. One exception is the UK, where in April 2021 we saw more companies active in SONIA than in LIBOR on our swaps platform. However, it is worth paying attention to what is happening in Asia’s main trading hubs – namely, Hong Kong, Singapore, and Tokyo.
A tale of three cities
Both Hong Kong and Tokyo exhibit a number of similarities when it comes to LIBOR transition. For a start, there appears to be some inertia among financial institutions towards the upcoming change. A Hong Kong Monetary Authority (HKMA) survey conducted in March last year found that more than a third of LIBOR-linked assets and liabilities, and half of derivatives contracts that mature after 2021 did not have sufficient fallbacks for LIBOR discontinuation. A similar survey from the Bank of Japan (BOJ) found that the focus on the pandemic has affected preparations for cessation – especially in IT upgrades and customer discussions.
This is a big deal. Both financial centres have enormous exposure to LIBOR. Hong Kong has HKD 4.8 trillion (USD 615 billion) of assets and HKD 1.6 trillion (USD 205 billion) of liabilities referenced to the old rate. In Japan, the number is even higher, with local institutions having an exposure of JPY 3 quadrillion (USD 29 trillion), according to Fitch Ratings.
We can explain some of the lack of progress in transition preparations in the two markets by looking at the second similarity – namely that Hong Kong and Tokyo are both taking a multiple rate approach. The existing Hong Kong-equivalent of LIBOR, HIBOR, will not be discontinued and it will run alongside the new local reference rate, HONIA. Japan follows a similar structure, with the original TIBOR rate co-existing with the newer TONA. By keeping the old rate, both markets remove some of the pressure from market participants, who might feel that they can rely on the older rate.
Singapore presents a sharp contrast to its peers in North Asia. The city state has settled on a plan to discontinue SIBOR and replace it with a single overnight rate, SORA. Locally, many in the industry are expecting the Monetary Authority of Singapore (MAS) to start supporting the new rate, perhaps as early as the summer, with the older rate available until the end of the year.
Market participants will therefore have no choice but to prepare for SORA in the very near future. Most institutions are still at the discussion stage, but the replacement rate is already being used, with a number of large Singaporean names issuing debt referenced against SORA. In light of the recent IBA announcement, we expect the pace of transition to pick up in the coming months.
Time to act
No matter where an individual firm is doing business, it is essential that they prepare in sufficient time for the end of the LIBOR era. This means taking action as soon as possible in order to avoid a logjam of operational work piling up towards the end of the year.
The main areas of focus are: testing systems to ensure that they are ready for the new trading environment, understanding how to actively transition portfolios away from the old rates, and preparing for different liquidity scenarios. Onboarding new rates and initiating customer engagement are other actions they can take to ensure that everything is in place for transition.
Beyond Asia’s largest and most international financial centres, there is a swathe of markets each with their own transition plans and implementation timetable – from Seoul all the way down to Jakarta. The local conditions might be different in each country, but the importance of preparedness is the same in every market.
LIBOR cessation has been well telegraphed by regulators and authorities for years. The deadline is quickly approaching. By acting early, clients can transition to the new rates on their own terms, whereas waiting until the last minute could lead to operational and liquidity costs.
We are currently in the middle of the process, where financial institutions know what they need to do and have time to execute their plans. Banks, investors, and corporates in Asia should all take note, and not leave it until it is too late.
Li Renn Tsai is Head of Product and Sales at Tradeweb Asia.