Market Turnover
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Benchmark Reform

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, and 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.

OTC Clear also targets to implement 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 19 Jun 2021.

Related Circulars:

          8 July 2020 Transition Plan from EONIA to €STR Discounting & Price Alignment for Cleared EUR Interest Rate Swaps
          21 September 2020 Amendments to the Clearing Rules and Clearing Procedures
          21 September 2020 SOFR Discounting Switch Notice
          25 September 2020 SOFR Discounting Switch Swap Compensation Election Result
          21 April 2021 Amendments to the Clearing Rules
          26 April 2021 SOFR Discounting Switch Notice - CCS, DFX and NDF
          3 May 2021 SOFR Discounting Switch Swap Compensation Election Result - CCS, DFX and NDF


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.

Useful Links:
OTC Clear Launches Clearing Services for HONIA-based Interest Rate Products
Clearing Service Launch of Interest Rate Swaps and Basis Swaps with Reference to New Floating Rate Options
Clearing Service Launch of Cross-currency interest rates swaps and basis swaps with reference to new Floating Rate Options and product feature enhancements

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 Fallbacks

IBOR Fallbacks Supplement is used to determine the replacement rates that would apply to derivatives trades referencing a particular benchmark if such benchmark becomes unavailable.

As part of the Benchmark Reform and to address the scenario where market participants continue to have exposure to an IBOR after it has been permanently discontinued (when major dealers would be unwilling and/or unable to give such quotes) or when it is no longer representative of its underlying market, on 23 October 2020, ISDA launched Supplement number 70 to the 2006 ISDA Definitions (the “IBOR Fallbacks Supplement”).  The IBOR Fallbacks Supplement amends ISDA’s standard definitions for interest rate derivatives to incorporate robust fallbacks for derivatives linked to certain IBORs and it takes effect in January 2021.


Key dates:

 

          23 October 2020  ISDA launched the IBOR Fallbacks Supplement to the 2006 ISDA Definitions and 2020 IBOR Fallbacks Protocol
          25 January 2021

Effective date of the IBOR Fallbacks Supplement and ISDA 2020 IBOR Fallbacks Protocol
(as between adhering parties) 

          5 March 2021 The UK Financial Conduct Authority (FCA) announced that all LIBOR settings for all currencies will either cease
to be provided by any administrator or no longer be representative immediately after the following dates:
  • 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

  • 30 June 2023: for US Dollar Overnight, 1-month, 3-month, 6-month and 12-month settings

Useful Reference Links:
FCA announcement on future cessation and loss of representativeness of the LIBOR benchmarks
ISDABenchmark Reform and Transition from LIBOR Page
ISDA IBOR Fallback Supplement
ISDA's Understanding IBOR Benchmark Fallbacks
ISDA/Bloomberg/Linklaters IBOR Fallbacks Factsheet
IBOR Transition Guide for Asia (July 2020) Published by ISDA, APLMA, ICMA and ASIFMA
HKMA Reform of Interest Rate Benchmarks Circular (July 2020)

 

OTC Clear’s Approach

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 will adopt 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.

For details, please refer to the circular: OTC Clear Circular OTCO/022/2020

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.

OTC Clear conducted a consultation on 31 March 2021 to get the Clearing Members’ feedbacks regarding the potential LIBOR cessation arrangements for the LIBOR-linked products.

 

FAQS

Q

Will there be a change in the OTC Clear Rules and Procedures as a result of the launch of the IBOR Fallbacks Supplement by ISDA?

A

No, the OTC Clear Rules and Procedures will not need to be changed as the ISDA IBOR Fallbacks Supplement has been adopted by OTC Clear issuing a circular to incorporate it by reference into the OTC Clear Clearing Rules.  The ISDA Definitions may be subject to subsequent amendments published by ISDA from time to time as adopted by OTC Clear.

 

For details on OTC Clear’s adoption of the ISDA Fallbacks Supplement, please refer to the circular OTCO/022/2020.

Q

When will OTC Clear adopt the new ISDA IBOR Fallbacks Supplement?

A 

From the Effective Date of 25 January 2021, OTC Clear will adopt 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.

 

For details on OTC Clear’s adoption of the ISDA Fallbacks Supplement, please refer to the circular OTCO/022/2020.

 Q

Will the ISDA IBOR Fallbacks Supplement apply to both new and existing trades?

 A

Yes, the IBOR Fallbacks Supplement will apply to Contracts that are registered with OTC Clear on or after the Effective Date of the IBOR Fallbacks Supplement .

 

Contract Terms of the Contracts that are registered with OTC Clear prior to the Effective Date will also be amended pursuant to the IBOR Fallbacks Supplement, with such amendment to take effect from the Effective Date.

 

For details on OTC Clear’s adoption of the ISDA Fallbacks Supplement, refer to the circular OTCO/022/2020.

 Q

Are Clearing Members required to adhere to IBOR Fallbacks Protocol in order for OTC Clear to adopt the ISDA IBOR Fallbacks Supplement for Contracts registered with OTC Clear?

 A

No, Clearing Members of OTC Clear are not required to adhere to the IBOR Fallbacks Protocol in order for OTC Clear to adopt the IBOR Fallbacks Supplement for Contracts that are registered with OTC Clear.

 

The IBOR Fallbacks Protocol is for market participants to incorporate the IBOR Fallbacks Supplement into their legacy non-cleared derivatives trades with other counterparties that choose to adhere to the protocol.

 

For details on OTC Clear’s adoption of the ISDA Fallbacks Supplement, refer to the circular OTCO/022/2020
 Q Are Clearing Members required to confirm their consent in order for OTC Clear to adopt the ISDA IBOR Fallbacks Supplement?
 A

Clearing Member’s consent is not required for OTC Clear to adopt the ISDA IBOR Fallbacks Supplement for Contracts that are registered with OTC Clear.

 

OTC Clear has the discretion to adopt amendments to the ISDA Definitions for the purpose of interpreting or implementing the contract terms as set out in the product specific terms under Rule 2207 and 2208 for Standard Rates Derivatives Contracts; Rule 2308 and 2309 for Non Deliverable Rates Derivatives Contracts and Rules 2507 and 2508 for Standard Cross-currency Rates Derivatives Contracts.

 

For details on OTC Clear’s adoption of the ISDA Fallbacks Supplement, refer to the circular OTCO/022/2020.

Q  Will there be any changes to existing reports as a result of OTC Clear's adoption of the ISDA IBOR Fallbacks Supplement?
A  OTC Clear is currently in the process of reviewing the technical development required to support the various IBOR Fallbacks.  It is anticipated that there may be minor changes to existing reports to include fields relevant to such fallbacks.  Further details will be shared with Clearing Members in due course.

 

 

 

 


Updated 04 Feb 2021