preparing for the end of ibor - deloitte us | audit ...€¦ · summary of rate differences (in...

Benchmark Reform Panel

Deloitte Touche Tohmatsu, 26 April 2019

Preparing for the end of IBOR

Preparing for the end of IBOR© 2019. For information, contact Deloitte China. 2

A brief historyThe rise and fall of LIBOR

LIBOR ScandalRegulators uncovered explicit manipulation by banks and

individuals to influence rate fixings intent on projecting

financial soundness, leading to billion dollar fines.

2012-2014

Publication1 Jan 1986, the British Bankers

Association (BBA) first published

LIBOR to manage derivatives IR risk,

there was a huge reliance on the

daily LIBOR fixing.

1986 Benchmark Reform2014 – Regulators propose development

of new reference rates.

2017 – FCA stated that by the end of

2021, the FCA would no longer

compel panel banks to submit

quotes for LIBOR

07/2018 – ISDA published consultation on

fallback provisions

09/2018 – FCA/PRA jointly issued “Dear

CEO letter”

2014 - Now

Financial CrisisA result of the financial crisis has been that banks are more

reluctant to lend to each other on an unsecured basis. The

liquidity and credit risks in LIBOR were exposed, and it

stopped being a proxy for the risk-free cost of borrowing.

2007-2008


Benchmark reforms have prompted a shift to alternative reference rates.Alternative Reference Rates (ARRs)

Region Rate Administrator Type Live

SONIA Bank of England Unsecured

SOFR Federal Reserve Secured

ESTER European Central Bank Unsecured

SARON SIX Swiss Exchange Secured

TONA Bank of Japan Unsecured

HONIA Treasury Markets Association Unsecured

x


The characteristics of new ARRs are qualitatively & quantitatively different from LIBOR

Comparing LIBOR and the Alternative Reference Rates

LIBOR ARR

Calculation Methodology

• Forward looking estimates. • Backward looking, transactions-based.

Publication time • 11am London time • Varying times per currency.

Term Structure • 7 rates from overnight to 12 months • Currently overnight rates only.

Credit Premium• Includes credit risk of unsecured

interbank borrowings• Closer proxy to risk-free.

Volumes

• Based on narrow range of contributor banks, diminishing interbank lending markets

• Based on robust, very liquid underlying markets. Less prone to manipulation.

Consistency/ Timing

• Quoted on the same basis and time for all 5 currencies

• Varying but objective methodology and times of publication

Administrator • Private sector • Usually administered by Central Banks.


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Rate

(%

)

Date

Overnight SOFR vs. Overnight LIBOR

SOFR

LIBOR

Summary of rate differences (in basis points)

Mean 4

Maximum 23

Minimum -61

96th Percentile 17

1st Percentile -14Source: Federal Reserve Bank of New York, Bloomberg


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HONIA and HIBOR Overnight

HONIA

Overnight HIBOR

Summary of rate differences (in basis points)

Mean 7.31

Maximum 86.89

Minimum -24.66

96% Percentile 22.69

1% Percentile -7.31

Source: Hang Seng Bank, Treasury Markets Association


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8/18/2016 11/26/2016 3/6/2017 6/14/2017 9/22/2017 12/31/2017 4/10/2018 7/19/2018 10/27/2018 2/4/2019 5/15/2019 8/23/2019

Percen

t

Date

Recent Movements in HONIA vs Averaged HONIA

HONIA

1m MA HONIA

3m MA HONIA

6m MA HONIA

Source: Bloomberg


Source: Bloomberg

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8/14/2013 12/27/2014 5/10/2016 9/22/2017 2/4/2019 6/18/2020

Percen

t

Date

3-Month Average of HONIA vs 3-Month HIBOR

3m HIBOR

HONIA 3m MA


There are 2 key elements to define fall-back rates, and adjustments to account for differences between LIBORs and the ARRs:

Derivatives Under ISDA

Account for Tenor1 Adjust for

change from term rate to overnight.

2Similarity with Overnight Index Swaps

3

Adjusted Risk-Free Rate (RFR)

ARRs are closer to risk free.

Apply a spread adjustment as a rough proxy to active IBORs.

Spread adjustment calculated to day before fall-back triggers.

Methodologies eliminate:

• Value transfer at time of fall-back

• Risk of manipulation

• Impact of market disruption

Spread Adjustment


‘Trigger events’ are defined events that would trigger a move to the IBOR replacement rate. Based on the most recent consultation papers of Alternative Reference Rates Committee (ARRC) and ISDA, cash and derivative products have slightly different triggers for the fallback.

Comparison of triggers – Cash vs Derivative Products

Trigger Events

Pre-Cessation Permanent Cessation

1. LIBOR fails to publish for 5 days

2. There are insufficient number of submissions for LIBOR

3. LIBOR becomes not representative or there is a prohibition on usage.

4. Administrator publicly announces that LIBOR has ceased or will cease permanently or indefinitely

5. Regulatory supervisor foradministrator of LIBOR, central bank, or relevant insolvency officials publicly announces that LIBOR has ceased or will cease permanently or indefinitely.

Cash Products a a a a a Derivatives

a a FSB issued letter on 12 March 2019 to urge harmonisation


IASB discussions are ongoing. Emerging topics include:Accounting Impacts: Financial Reporting under IFRS

Contract modification and derecognition

Hedge accounting: pre-transition considerations

Hedge accounting: transition

considerations

IASB proposed optional relief regarding “highly

probable requirement” and “prospective assessments”


Risks & challenges to the transition

Key

risks:

Getting

Buy-in

Large

Contracts

Diversity

of ARRs

Market-wide

coordination

Uncertain

Future

Increased conduct risk

Operational & regulatory issues

Insufficient industry action

Accounting implications

Contractual frustration and legal risk

Firms do not focus on IBOR transition globally, outside of LIBOR

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