Overview
The widely used Interbank Offered Rates (IBORs) rely on rates submitted by panel banks. In response to the G20 request to improve the robustness and integrity of financial benchmarks, regulatory authorities around the world have announced efforts to encourage adoption of alternative overnight risk-free rates (RFRs) underpinned by actual transactions.
As a result, a number of jurisdictions have identified RFRs for major IBOR currencies and developed a transition plan for such RFRs. In particular, the Alternative Reference Rate Committee (ARRC), convened by the Federal Reserve Board and the Federal Reserve Bank of New York, and the European Central Bank (ECB) have identified Secured Overnight Financing Rate (SOFR) and Euro Short Term Rate (€STR) as the RFR for USD and EUR respectively. The Treasury Markets Association (TMA) has proposed Hong Kong Dollar Overnight Index Average (HONIA) as the RFR for HKD.
Discounting Switch
One major step in reforming the interest rate benchmarks is to switch the discount rate and Price Alignment Interest (PAI) calculation reference rate to RFRs. The objective of this exercise is to increase market’s hedging and trading opportunities of the RFR-based swaps, which would improve the liquidity of the RFRs market.
In line with the transition plans of other global Central Counterparties (CCPs), OTC Clear has implemented the discounting switch for EUR Interest Rate Swaps (IRS) from Euro Overnight Index Average (EONIA) to €STR on 24 July 2020, the discounting switch for USD IRS and Non-deliverable Interest Rate Swaps (NDIRS) from Effective Federal Funds Rate (FedFund) to SOFR on 16 October 2020 and the discounting switch for cross-currency products including Cross Currency Swap (CCS), Deliverable FX Derivatives (DFX) and Non Deliverable FX Derivatives (NDF) from FedFund to SOFR on 18 June 2021.
Related Circulars:
Related Rules and Clearing Procedures:
Chapter 10A Interest Rate Transition
Supplement I SOFR Discounting Switch Supplement
New RFR-based Products
Another major step in the benchmark reform is to support and promote derivatives products referencing RFRs. As market participants started adopting and trading derivatives with reference to the new benchmarks, OTC Clear expanded its IRS product coverage and launched its clearing services for products referencing SOFR, HONIA and €STR on 6 July 2020.
OTC Clear further expanded the clearing services to CCS with references to SOFR and HONIA on 10 May 2021.
OTC Clear started to accept IRS and CCS with three new ISDA compounding conventions, namely Lookback, Lockout, and Observation Period Shift on 22 May 2023.
Related Circulars:
In Hong Kong, TMA has identified HONIA as the RFR for HKD. To provide greater transparency for the new HONIA market, OTC Clear has developed a proxy methodology which simulates a HONIA curve since 6 July 2020. Such services would facilitate HONIA rate projection and hence increase the liquidity of the HONIA market.
Useful Links:
HONIA Data Publication by the Treasury
Markets Association
HONIA
Curve Data by HKEx
IBOR Cessation
IBOR Fallbacks
On 23 October 2020, ISDA launched Supplement number 70 to the 2006 ISDA Definitions (the “IBOR Fallbacks Supplement”) to address the scenario where market participants continue to have exposure to an IBOR after it has been permanently discontinued or when it is no longer representative of its underlying market. The IBOR Fallbacks Supplement takes effect in January 2021.
Shortly following its launch by ISDA, OTC Clear implemented the fallbacks in the IBOR Fallbacks Supplement as of the Effective Date (25 January 2021) in all of its Contracts including the legacy cleared derivatives transactions. As of the Effective Date, OTC Clear adopted the IBOR Fallbacks Supplement in its entirety for the purposes of interpreting or implementing the Contract Terms of each Contract registered with OTC Clear irrespective of its Registration Time.
Incorporating IBOR Fallbacks is an important measure to mitigate the risks associated with IBOR discontinuation. Regulatory bodies also encourage market participants to take proactive actions to transition away from LIBOR ahead of the LIBOR cessation effective date. Various international working groups have initiated discussions around active transition methods to replace existing LIBOR trades with the alternative benchmark rate (i.e. SOFR for the case of USD) prior to the cessation of LIBOR.
Related Circulars:
Regulatory Update
On 5 March 2021, the UK Financial Conduct Authority (FCA) announced that all LIBOR settings for all currencies will either cease or no longer be representative immediately after the following dates:
(i) 31 December 2021 - for Sterling, Euro, Swiss Franc and Japanese Yen LIBOR settings in all tenors, and US Dollar LIBOR 1-week and 2-month settings; and
(ii) 30 June 2023 - for US Dollar LIBOR Overnight, 1-month, 3-month, 6-month and 12-month settings.
Among all the IBOR settings in the FCA announcement, OTC Clear had been offering clearing services for derivatives products referencing Euro LIBOR and US Dollar LIBOR.
Product Discontinuation
In response to Euro LIBOR cessation by end of 2021, OTC Clear has discontinued the clearing services for the EUR IRS referencing EUR LIBOR on 4 October 2021.
Following the announcement of the FCA on the permanent cessation of US Dollar LIBOR 1-week and 2-month tenors immediately after 31 December 2021, OTC Clear has stopped accepting the aforementioned LIBOR tenors for interpolation and stub calculation period on 1 January 2022 and added the 1-day a replacement tenor on 17 December 2021.
Related Circulars:
OTC Clear’s Approach – Active USD LIBOR to SOFR Conversion
Shortly after the announcement made by FCA in March 2021, OTC Clear conducted a market consultation to seek feedback from Clearing Members in respect of LIBOR cessation approach. Clearing Members provided feedback during the market consultation that OTC Clear should actively convert the outstanding cleared USD LIBOR legacy contracts into SOFR contracts shortly before the Index Cessation Effective Date (ICED) on the first London Banking Day after 30 June 2023, instead of using the ISDA Fallback Arrangement. OTC Clear will adopt the conversion approach, which is aligned with other global CCPs’ practices and market expectations.
To reduce the outstanding contracts subject to the conversion, OTC Clear suspended accepting new USD Basis Swaps referencing USD LIBOR and new THB NDIRS referencing THBFIX on 3 October 2022.
The in-scope products for the conversion are single currency IRS and CCS referencing USD LIBOR. Outstanding USD LIBOR IRS and CCS contracts with all coupons fixed by representative USD LIBOR are not subject to the conversion.
Pursuant to the Floating Rate Conversion Notice published on 3 May 2023, OTC Clear successfully conducted the USD LIBOR to SOFR conversion with the “Floating Rate Conversion Date” on 19 May 2023 and ceased to accept new USD LIBOR IRS, CCS, Basis Swaps referencing USD LIBOR and new THB NDIRS referencing THBFIX on 22 May 2023.
Related Circulars:
Related Rules and Clearing Procedures:
Chapter 10B Floating Rate Conversion
Supplement II SOFR Floating Rate Conversion Supplement