Frequently Asked Questions (FAQs) of IBOR Reforms

1. What is IBOR?

Interbank Offered Rate (“IBOR”) refers to the different interest rate benchmarks derived from the rate at which major global banks lend to one another in the international interbank market for short-term loans in corresponding markets and currencies. Common examples of IBOR include the London Interbank Offered Rate (“LIBOR”), Euro Interbank Offered Rate (“EURIBOR”), and Hong Kong Interbank Offered Rate (“HIBOR”).

LIBOR is recognised worldwide as one of the most widely used benchmark of short-term interest rates for financial products’ interest payment calculation, including but not limited to loans, derivatives, credit card and mortgages.

LIBOR is refreshed and published in five currencies (including pound sterling, euro, Japanese yen, Swiss franc and US dollar) on each London business day based on the average of the quotations received from the LIBOR panel banks across the globe. LIBOR can be an overnight rate or a forward-looking term rate which covers six interest periods, ranging from 1 week to 12 months.

2. What is LIBOR transition and why is it happening?

Despite the wide application of IBOR in the financial contracts, the current mechanism of determining interbank offered rates has long been criticised as inadequate and inherently subject to subjectivity due to its heavy reliance on "expert judgement" during the submission of the quotes by the panel banks. As part of the global reform initiative to improve robustness of the financial benchmarks, the supervisory authority of LIBOR, UK Financial Conduct Authority (“FCA”),  has taken the lead and announced that FCA will no longer compel panel banks to make submission for LIBOR after 2021. This means that LIBOR is expected to be discontinued, most likely after the end of 2021.

Regulators across the globe have then released guidance asking banks in each jurisdiction with financial products and contracts that references LIBOR to take action and transit away to more robust and reliably determined alternative reference rates (“ARRs”). As such, banks with exposures across UK, US, EU and Hong Kong jurisdictions are now acting to phase out the use of LIBOR and use ARR as a replacement for existing and new products and contracts, prior to the end of 2021, to avoid any market disruption. In particular, the Hong Kong Monetary Authority (“HKMA”) has released its expectations on banks to cease new LIBOR linked cash products that will mature after end of 2021 by end of June 2021.

3. Are there alternatives to LIBOR?

In the five LIBOR currency areas (i.e. the US, Euro Zone, Japan, the UK and Switzerland), relevant authorities have identified transaction based overnight interest rates as the alternative reference rates (“ARRs”) for LIBOR (Table 1).

Table 1 - ARRs

4. How can these alternative reference rates be used in financial transactions, given they are overnight rates without a term structure like LIBOR?

Interest payments based on overnight rates are generally calculated using the method of simple or compounded averaging. Currently, the most popular calculation method is compounding in arrears. Certain overseas authorities are also exploring the possibility of deriving a term structure for these overnight rates.

However, a firm timetable for doing this has yet to be established. As such, customers are advised to rely on calculation methods that have already been developed (such as those aforementioned) and promptly consult their banks on how these can be used, and also look into necessary changes that may be required, including to IT systems.

5. Will HIBOR be discontinued?

In Hong Kong, there is no plan to discontinue HIBOR as it remains a credible financial benchmark. Nevertheless, we have identified an alternative reference rate for HIBOR following the international trend, which is the HKD Overnight Index Average (“HONIA”). Market participants are free to choose between HIBOR and HONIA.

6. How are the current USD LIBOR dependent products adopting SOFR?

SOFR is the identified alternative benchmark rate to USD LIBOR. Although USD LIBOR still remains the dominant rate, there are a number of market developments for the use of SOFR:

• Various parties have issued SOFR-based floating rate notes (“FRNs”), with total issuance exceeding US$300 billion. The Federal Home Loan Banking System regularly issues SOFR FRNs and offers SOFR advances to member banks.
• Issuers have reported that SOFR FRNs are obtaining better rates than comparable LIBOR FRNs, with wider investor base for the new instruments.
• Real Estate Mortgage Investment Conduit issued the first SOFR-based securitization in May 2019.

7. Why should I (as a customer) be concerned?

LIBOR, especially USD LIBOR, is the most widely used benchmark rate for a variety of financial contracts, including loans and derivatives. As most existing LIBOR contracts do not stipulate how contract terms would be managed should LIBOR become permanently unavailable[1], these contracts could be subject to disputes or litigation if the parties to the contract fail to agree on a replacement rate or other fallback arrangements in advance.

8. How does the difference in benchmark rate impact customers?

Compared to IBOR where an active underlying market is absent and is only backed by limited underpinning transactions, ARRs are more transparent as they are based on real transaction data in active markets, and are almost overnight risk-free reference rate (“RFR”) with close correlation with other money market rates, which makes them less vulnerable to manipulation and form a more reliable basis for all financial contracts relying on a reference rate.

However, given the nature of ARRs where it's based on historical transaction data, ARRs are backward-looking rates instead of forward-looking rates as if IBORs are. This implies that ARRs may not have a term structure like IBOR (e.g. 1 month, 3-month, 12-month LIBOR etc.) which can be used to determine the future interest for different period based short term contracts.

9. How do I prepare for LIBOR reform?

First, customers (including corporate and retail customers) should take steps to identify and review all their existing contracts that use LIBOR as the reference rate (e.g. loans, derivatives, floating rate notes, etc.). If the contracts do not contain provisions setting out how LIBOR will be replaced when it becomes unavailable, you should talk to your banks and counterparties to build in the alternative reference rates as a fallback.

Furthermore, you should avoid entering into new contracts with a maturity beyond 2021 using LIBOR as reference rates. Instead, you should consider using the alternative reference rates set out above for new contracts.

10. Who can I contact if I have more questions?

For more background information about the cessation of LIBOR and relevant transition work being undertaken, please refer to the following website:

• https://www.tma.org.hk/en_market_LIBOR.aspx

For specific questions about your existing LIBOR contracts and how these should be handled, please contact your Relationship Manager, and seek advice from your lawyers or financial advisors as appropriate.

[1] The contract terms are referred to as “fallback language”. Fallback language refers to the legal provisions in a contract which is applied if the interest reference rate in the product is discontinued and consists of a conditional trigger event and a replacement rate for the said trigger event.