LIBOR transition in the Asia Pacific region: Time is running out

27 May 2021

Nathan Bourne, ASIC’s Senior Executive Leader, Markets Infrastructure, recently spoke about the London Inter-Bank Offered Rate (LIBOR) transition at a webinar hosted by Bloomberg Professional Services and the International Capital Market Association (ICMA) to launch their Guide to Tough Legacy Bonds in Asia Pacific.

The webinar examined the current state of play in relation to so-called ‘tough legacy’ issues in bond markets in the Asia Pacific region.

ASIC considers LIBOR transition to be a significant priority. To ensure a smooth changeover after 31 December 2021, it’s vital that firms and regulators alike continue to prioritise this important work.

Since 2018, ASIC has highlighted the need to prepare for LIBOR transition. We have published several communications to provide guidance and clarification for the industry, including an information sheet, INFO 252 Managing conduct risk during LIBOR transition.

Other regulators have also issued guidance and timelines on LIBOR transition including the Hong Kong Monetary Authority, the Monetary Authority of Singapore and Japan’s Financial Services Agency.

There are significant risks associated with a failure to adequately prepare for the transition. While we acknowledge there are still uncertainties ahead, Australian entities have access to all the tools necessary to complete the transition. As such, ASIC encourages all firms to take necessary steps sooner rather than later.

Continuously review your LIBOR transition strategy

LIBOR transition dependencies are constantly evolving and as such, firms should be vigilant in reviewing their transition strategies to reflect additional information as it becomes available.

Several significant milestones have already been reached. On 23 October 2020, the International Swaps and Derivatives Association (ISDA) released the ISDA 2020 IBOR Fallbacks Supplement to the 2006 ISDA Definitions and ISDA 2020 IBOR Fallbacks Protocol. The Loan Market Association and Asia-Pacific Loan Market Association have also issued guidance.

Most large firms are on track to keep pace with the timelines set by each of the relevant global working groups and are well positioned for LIBOR transition. However, there are still significant tasks to complete. Increased engagement from the buy-side firms and corporates – both on the identification of relevant alternative reference rates and operational readiness – will be key. 

Multi-rate jurisdictions in the Asia Pacific region

Mr Bourne examined the nuances relevant to global firms operating in the Asia Pacific region. In particular, jurisdictions with a multi-rate approach where they have pursued the development of risk-free rates in addition to domestic Inter-Bank Offered Rates.

‘For these jurisdictions where multiple rates coexist, firms need to determine the most appropriate rate when fulfilling various purposes and needs,’ Mr Bourne said.

‘The next six months will be challenging for the bond market, but we are seeing encouraging development from LIBOR jurisdictions. The US, UK and EU are set to have legislative processes for tough legacy contracts, and the Sterling bond market has seen an increase in active transition from Sterling LIBOR to the Sterling Overnight Index Average (SONIA).

‘In Australia, ASIC’s view is that firms should, as soon as practicable, stop the sale and issuance of LIBOR-referenced contracts that expire after relevant cessation dates if they do not have robust fallback language and appropriate client communication. More importantly, firms should completely cease offering new LIBOR products after 31 December 2021.

‘ASIC urges all market participants to consider the milestones and roadmaps set out by each of the risk-free rates (RFR) working groups and accelerate the adoption of RFRs in new contracts, as well as active conversion of legacy LIBOR contracts.’

LIBOR in Australia

The total notional LIBOR exposure for key Australian institutions is declining. Despite key firms being operationally ready, the adoption of RFR products has been slower than expected, due to a lack of client demand and slow uptake of RFR products in the US.

‘Approximately 75% of post-cessation date exposure have adequate fallback provisions, however, this figure includes both derivatives and cash products,’ said Mr Bourne.

‘If split by product types, the number of contracts with robust fallbacks falls drastically for cash products. The cash market is moving at a much slower pace than the derivatives market for both amendment of existing LIBOR contracts and the adoption of new RFR products. Only 14% of post-cessation date loans have robust fallbacks. As such, the extension of USD LIBOR has been welcomed by industry. The extension does not apply to new contracts.’

Mr Bourne added that staff education and training is essential to ensure new LIBOR contracts are not offered to clients.

‘ASIC’s recent engagements with market participants have shown that the best‑prepared firms have implemented controls and escalation processes to question the rationale of new LIBOR contracts,’ he explained. ‘Clients can then be offered alternative solutions.’

Legislative solutions for ‘tough legacy’ contracts

Key LIBOR jurisdictions have made significant progress in identifying and implementing legislative solutions for legacy contracts. As such, some entities are choosing to rely on fallbacks and legislative solutions instead of taking a proactive approach.

Fallback language and legislative solutions are (and always will be) a ‘seatbelt’ solution; ASIC believes firms should examine whether this passive approach is the best option.

‘Legislative solutions are designed to assist proactive transition by removing uncertainties and obstacles to active transition efforts. No form of legislative solution will be broad enough to cover every single form of claims or disputes. Active transition is the best method to mitigate litigation and conduct risks,’ said Mr Bourne.

Conduct issues

From a conduct perspective, broad reliance on fallback language and legislative solutions does not prioritise positive client outcomes because it does not guarantee legal certainty. In addition, this reliance does not ensure firms and their counterparties are ready for the transition.

‘Entities should adopt an outcomes-focused approach to the transition process. Your clients should understand the impact of the LIBOR transition and dependencies associated with the transition process. Your counterparties and clients may not have the same degree of knowledge as you, and may have a limited ability to negotiate terms,’ said Mr Bourne.

‘ASIC expect firms to:

  • use their knowledge to help clients make decisions about the appropriateness of relying on fallbacks and legislative solution
  • be transparent during the transition process
  • keep evidence to show that the final decision was reached through fair negotiations.

‘Buy-side entities have a duty to ensure their clients are not disadvantaged during the transition, especially in the contract negotiation process. It’s important for buy-side entities to engage with their service providers and choose the best available option.

‘We encourage these firms to engage with their service providers now if they have not already done so. Conversations with their service providers should have the same level of rigour and granularity as the questions the regulators have been asking.

‘Again, we emphasise that corporates and buy-side firms should not wait any longer. To assist the industry, ASIC continues to provide guidance and clarification for buy-side firms and corporations that may be facing difficulties in dealing with the scope of LIBOR transition.’

Alternative reference rates

Mr Bourne noted that some participants have adopted a ‘wait and see’ approach to the transition, based upon the assumption that market convention may move towards a term rate.

‘On this, I’d recommend firms amend existing LIBOR-referenced contracts with the most suitable replacement rate based on clients’ objectives and needs,’ said Mr Bourne.

‘The best way to pick a suitable replacement rate is to have open and transparent discussions with clients about alternative solutions and options that are suitable to clients’ needs.’

Next steps

ASIC and the Australian Prudential Regulation Authority (APRA) will continue to engage with key institutions to ensure they are keeping pace with international timelines and milestones.

ASIC also intends to start a second round of communication with corporations and buy-side firms to highlight the urgency of LIBOR transition. ASIC will continue to monitor transition progress and provide guidance and clarification as necessary.

More information:

This article is based on a speech by Nathan Bourne, given on 25 May 2021 at the ICMA-Bloomberg LIBOR Transition: Tough Legacy Bonds in Asia Pacific webinar.