Reform of interest rate benchmarks

Our Ref.: B1/15C
10 July 2020
The Chief Executive
All Authorized Institutions
Dear Sir / Madam,
Reform of interest rate benchmarks
I am writing to update you on the latest results of the Survey on Reform of Interest Rate Benchmarks and the key milestones that authorized institutions (AIs) should endeavour to achieve in the transition to alternative reference rates (ARRs). Latest survey results The latest results of the survey showed that the amount of LIBOR-linked exposures maturing beyond 2021 and having no adequate fall-back provisions had grown in the six months ending 31 March 2020. This suggested that the risks associated with the benchmark reform continued to build up in the banking system. That said, AIs had made further progress in their preparation for the transition. By the end of March 2020, the proportion of AIs which had developed a bank-wide transition plan increased by 23% to 61%. In fact, all except a few smaller institutions have already come up with a transition plan, based on the most recent information collected by the Hong Kong Monetary Authority (HKMA). More details of the survey results can be found in Annex 1. Transition milestones Notwithstanding the outbreak of COVID-19, financial authorities around the world remain committed to the original transition timeline. The Financial Stability Board (FSB) issued a statement on 1 July 2020, reaffirming its view that firms across all jurisdictions should continue to remove remaining dependencies on LIBOR by the end of 2021. The Working Group on Sterling Risk-Free Reference Rates in the UK and the Alternative Reference Rates Committee in the US have issued further statements to supplement their earlier work plans with detailed transition milestones. These include clear timelines for financial institutions to offer non-LIBOR linked products and to cease issuing products referencing LIBOR. More details on recent major developments relating to the benchmark reform are contained in Annex 2.

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  Having regard to the developments in other financial markets, the HKMA has, in consultation with the Treasury Markets Association (TMA), developed the following transition milestones which AIs are expected to achieve: - (i) AIs should be in a position to offer products referencing the ARRs to LIBOR from 1 January 2021; (ii) Adequate fall-back provisions should be included in all newly issued LIBOR-linked contracts that will mature after 2021 from 1 January 2021; and (iii) AIs should cease to issue new LIBOR-linked products that will mature after 2021 by 30 June 2021. The HKMA expects AIs to endeavour to achieve the above transition milestones and put in place a detailed work plan (by products and by business lines) for this purpose. AIs having difficulties to meet this timeline should discuss with the HKMA as soon as they are aware of their inability to comply with this industry standard. To assist AIs to prepare for the transition, the Asia Securities Industry and Financial Markets Association (ASIFMA), at the HKMA’s request, has kindly agreed to develop a transition guide. The HKMA is also working with the TMA to develop a self-explanatory note about the benchmark reform, which AIs can distribute to their corporate customers to impress upon them the need to make early preparations. The ASIFMA transition guide and the note for corporates will be uploaded to the TMA’s dedicated webpage for the benchmark reform once they are ready. Separately, the HKMA, together with the TMA, are evaluating the need for suitable fall-back provisions for HIBOR contracts, although as pointed out in previous communications there is no intention to discontinue the local benchmark. The HKMA will continue to engage the industry proactively to ensure a smooth transition to the ARRs. Should you have any questions about this letter, please contact Mr Gordon Wong on 2878-1272 or Mr Anthony Choy on 2878-1547. Yours faithfully, Raymond Chan Executive Director (Banking Supervision) Encl.

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Annex 1
Results of Survey on Reform of Interest Rate Benchmarks for Q2 2020 (Figures in parentheses represent changes versus six months ago)

1. Hong Kong banking sector’s exposures referencing LIBOR (LIBOR exposures)
   (HKS trillion, as at end-March 2020) | Assets Liabilities Derivatives Total amount of LIBOR exposures ot9) $4.8 ($0.3) $1.6 (-) $34.7 (+$0.1) as a % of total assets or liabilities denominated in foreign currencies LIBOR exposures which will mature after end-2021 of which without adequate fall-back outstanding amount as a % of total LIBOR assets, o 0) 7 0 liabilities or derivatives 35% Crappy 39% (+llppy) 50% (+Sppt) 30% (一) 11% (--) N/A $1.9 (+504) $0.7 (+30.2) $18.1 (+$2.0) $1.7 (+303) $0.6 (+30.1) $17.4 (+$1.9) Note: Includes exposures referencing LIBOR in five currencies (i.e. USD, EUR, GBP, JPY and CHF), as well as benchmarks calculated based on LIBOR, including Singapore Dollar Swap Offer Rate (SOR), Thai Baht Interest Rate Fixing (THBFIX), Mumbai Interbank Forward Offer Rate (MIFOR) and Philippine Interbank Reference Rate (PHIREF).
2. Hong Kong banking sector’s exposures referencing HIBOR (HIBOR exposures)
   (HKS trillion, as at end-March 2020) | Assets Liabilities | Derivatives Total amount of HIBOR exposures $4.5 (-50.1) | $0.2 (-) $12.1 (-$0.1) as a % of total assets or liabilities denominated in HKD 48% (-1ppt) 2% (=) N/A
3. Als’ preparation for transition to alternative reference rates (ARRS)
   Key components in Als’ preparatory work for transition to % Als having the ARRs (mote) component in place Establishment of a steering committee and/or appointment of a senior executive for overseeing the preparation for transition 85% (+22ppt) Development of a bank-wide transition plan 61% (+23ppt) Quantification and monitoring of LIBOR exposures 64% (+16ppt) Impact assessment across businesses and functions 51% (+9ppt) Identification and evaluation of risk associated with the transition 48% (+10ppt) Development of a plan to introduce ARR products 46% (+18ppt) Identification of affected IT systems and development of a plan to 45% (+6ppt) upgrade these systems Identification of affected internal models and development of a ° . 36% (--) plan to modify these models Development of a plan to reduce LIBOR exposures 31% (+6ppt) Development of a plan to renegotiate LIBOR-linked contracts 31% (+7ppt) Note: Based on latest information collected by the HKMA, all except a few smaller Als have developed a bank-wide transition plan with proper governance in place to oversee the transition.

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Annex 2
Latest Developments in relation to Benchmark Reform International developments on benchmark reform and transition timeline Having discussed the impact of COVID-19 on global benchmark transition, the Financial Stability Board (FSB) published a statement on 1 July 2020, reaffirming its view that financial and non-financial sector firms across all jurisdictions should continue their efforts in making wider use of risk-free rates in order to reduce reliance on Interbank Offered Rates (IBORs) where appropriate and in particular to remove remaining dependencies on London Interbank Offered Rate (LIBOR) by the end of 2021. The FSB and the Basel Committee on Banking Supervision (BCBS) published a report on Supervisory Issues associated with Benchmark Transition on 9 July 2020. The report includes, among other things, insights on remaining challenges to transition based on earlier surveys undertaken by the FSB, the BCBS and the International Association of Insurance Supervisors. The Alternative Reference Rates Committee in the US (ARRC) published on 27 May 2020 a set of recommended best practices which include transition milestones specific to different types of financial products referencing USD LIBOR (e.g. floating rate notes, business loans, securitisations and derivatives). These milestones cover incorporation of fall-back provisions, technological and operational readiness of third-party vendors relevant to the transition, cessation of using USD LIBOR in new contracts and selection of fall-back rates. Recognising that amending existing LIBOR-linked contracts will be challenging or even impossible for some products, the ARRC released in March 2020 a proposal for New York State legislation to minimise legal uncertainty and adverse economic impacts that may arise from LIBOR transition. The proposed legislation would: (a) prohibit a party from refusing to perform its contractual obligations or declaring a breach of contracts as a result of LIBOR discontinuation or the use of another benchmark recommended by the legislation; (b) establish that the benchmark recommended by the legislation is a commercially reasonable substitute for and commercially substantial equivalent to LIBOR; and (c) provide a safe harbour from litigation for the use of the benchmark recommended by the legislation. The Working Group on Sterling Risk-Free Reference Rates in the UK (RFRWG) issued a statement on 29 April 2020 that includes an updated timeline for LIBOR transition. Specifically, lenders are expected to be in a position to offer non￾LIBOR linked products by the end of Q3 2020 and to include contractual arrangements in all new and re-financed LIBOR-referencing loans products after the end of Q3 2020 to facilitate conversion to alternative reference rates (ARRS) ahead of end-2021. RFRWG also recommended that all new issuance of GBP LIBOR-referencing loan products that expire after the end of 2021 to cease by the end of Q1 2021.

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The UK Government announced on 23 June 2020 its intention to bring forward legislation to give the Financial Conduct Authority (FCA) enhanced powers to direct the administrator of LIBOR to change the methodology used to compile the benchmark. These powers could help deal with “tough legacy” contracts that cannot transition away from LIBOR. The FCA will publish statements of policy on its approach to potential use of these powers after further engagement with stakeholders domestically and internationally. At the meeting of the National Working Group on Swiss Franc Reference Rates on 7 May 2020, the Swiss Financial Market Supervisory Authority (FINMA) reiterated its expectation that market participants should undertake all necessary steps to ensure LIBOR will be replaced by the end of 2021. Market participants were also expected to make substantial progress in replacing CHF LIBOR-linked cash products with those referencing Swiss Average Rate Overnight by the end of 2020, to take proactive actions to issue new products referencing ARRs, and to undertake testing of relevant IT systems, models and tools. Clarifications of the Basel Framework The BCBS published on 5 June 2020 a set of answers to frequently asked questions (FAQs) that the BCBS has agreed to add to the Basel Framework to help promote consistent interpretation of the framework. The FAQs cover, among others, a range of issues relating to the benchmark reform, including the definition of capital, market risk, counterparty credit risk, liquidity and operational risk. Publication of compounded indices for ARRs The Bank of England (BoE) will start publishing a daily Sterling Overnight Index Average (SONIA) Compounded Index from 3 August 2020 to facilitate market participants’ calculation of compounded interest rates based on SONIA.
i. The Treasury Markets Association (TMA) started publishing in May 2020 the
HKD Overnight Index Average (HONIA) Average (for fixed 30-day, 90-day and 180-day) and the HONIA Index in its website.