Keynote Address at ISDA Virtual Conference: Benchmark Strategies Forum Asia Pacific
17 Mar 2021
Keynote Address at ISDA Virtual Conference: Benchmark Strategies Forum Asia Pacific
Edmond Lau, Senior Executive Director, Hong Kong Monetary Authority
- Good morning. I’m very glad to join you virtually today at this ISDA conference. First of all, let me take this opportunity to thank ISDA for organising this event and inviting me to speak here. As we moved into 2021 which is a critical year for LIBOR transition, this subject has become one of the most topical talks in the market. I understand that there will be three panels in today’s conference, which will further discuss some of the issues and challenges arising from LIBOR transition. With the presence of all the distinguished speakers at this conference, I’m sure that we will all benefit a lot from the conference today and get valuable insights on useful ways and approaches to a smooth LIBOR transition.
- I think no one would disagree that LIBOR transition is one of the key priorities for the global financial markets this year, with the backdrop that LIBOR has been so deeply ingrained in the market, and widely used across multiple asset classes globally.
- Hong Kong is the third largest USD trading centre in the world, right after London and New York. Given the large amount of USD transactions in our economy and also our close linkages with other financial markets around the world, it is inevitable that there is a considerable amount of financial activities linked to LIBOR in our financial market. According to the HKMA’s latest survey results, there were US$615 billion of assets and US$180 billion of liabilities in our banking system referencing LIBOR at the end of September 2020, representing about 30% and 10% respectively of the banking system’s total assets and total liabilities denominated in foreign currencies. Additionally, there were derivatives contracts with an aggregate amount of US$4.1 trillion in notional value referencing LIBOR. The sheer size of these LIBOR-based transactions speak for the importance of ensuring a smooth and orderly LIBOR transition in the banking sector.
- To facilitate our banking sector in preparing for this transition, the HKMA issued in July 2020 a series of “transition milestones” for banks. The three milestones are:
||First, we expect banks to be in a position to offer products referencing the alternative reference rates to LIBOR from 1 January 2021;
||Second, we require banks to include adequate fall-back provisions in all newly issued LIBOR-linked contracts that will mature after 2021 from 1 January 2021; and
||Third, banks should cease to issue new LIBOR-linked products that will mature after 2021 by 30 June 2021.
- While I’m pleased to note the growing awareness of LIBOR transition across the financial markets, the work ahead remains substantial. As we get closer and closer to end-2021, it is important for us to continue our efforts to facilitate transition. In that respect, I would like to highlight three crucial elements that we think are essential to LIBOR transition, and hopefully they could offer some useful guidance to the market as we move along this unprecedented journey. To keep it short and simple, I would summarise these elements by 3Cs, which are Capability, Coordination and Commitment.
- Let me start with the first “C”, which is Capability. We all know LIBOR cessation is going to happen, and all of us want to ensure that the transition will take place as smoothly as possible. A critical element in achieving this goal is to have the right toolkit and necessary capabilities to manage the transition. When I say Capability, I am referring to the operational and system capabilities of a bank that would enable a transition from LIBOR to the alternative reference rates in their day-to-day trading activities and workflows.
- We appreciate that a lot of work is underway to support this transition, such as IT system set-ups, operational model adjustments, risk management and accounting system upgrades, to name but a few. All these ground work is fundamental to the implementation of the transition, especially with regard to the different characteristics of LIBOR vis-à-vis the alternative reference rates, which would no doubt bring about changes to our market conventions and business practices that have been in place for years.
- In fact, that is also why we have asked banks, as part of our transition milestones, to get themselves ready, with effect from this year, to offer products referencing the alternative reference rates to LIBOR. Having the necessary operational and system capabilities is a vital building block in supporting any new product offerings. As at today, we are pleased to note that many banks in Hong Kong can offer products referencing the alternative reference rates.
- At the same time, we understand the importance of promoting market awareness, and encourage all relevant parties, not only banks, but also their corporate clients, to get prepared and build the necessary capabilities in supporting this transition. On this front, the HKMA has been active in working with the industry associations to host various webinars to keep the practitioners up to speed and to facilitate contact among individual institutions to enable timely exchange of views and information, e.g., on the relevant tax and accounting issues. Moreover, the HKMA has worked closely with the Treasury Markets Association (TMA) to develop a short note for corporate treasurers on the benchmark reforms, and encouraged banks to distribute it to their corporate customers to impress upon them the need to make early preparation.
- The second “C” is Coordination. In addition to having the right toolkit as I just described, it is equally important to ensure effective coordination to address issues relating to LIBOR transition that are of common interest to the market.
- On this, I would like to applaud the hard work and rigorous efforts of industry organisations like ISDA in bringing together market participants across the globe to discuss and work collectively in developing industry-wide solutions and driving market consensus. Given the evolving and complex nature of this subject, the ongoing dialogue with market participants also brings firms up to speed on the latest developments and enhance their readiness for the transition.
- One example I would like to share is the IBOR (interbank offered rates) Fallbacks Supplement and Protocol launched by ISDA, which took effect in January. These documents enable market participants to incorporate appropriate fallbacks into their new and legacy derivatives contracts referenced to key IBORs, including LIBOR. This is an especially effective move by ISDA in helping the industry prepare for the cessation of LIBOR. And, thanks to ISDA’s efforts in promoting a wider use of these documents, more than 13,000 firms across the globe – from Asia, Europe, the US, to the rest of the world have already adhered to the protocol. Without doubt, the ISDA protocol provides an efficient way for market participants to handle their legacy contracts, and offers a viable back-up for LIBOR cessation.
- We strongly encourage banks in Hong Kong to adhere to these documents. Having said that, we understand that the documents may not be able to resolve all the issues for the legacy derivative contracts. In particular, some commercial counterparties may prefer tailor-made solutions for their LIBOR-linked contracts. In this respect, we note that ISDA has also published templates to help firms bilaterally agree with their counterparties to include the new fallbacks into their legacy derivatives transactions. This provides market participants with greater flexibility when considering the best way forward for their own cases.
- But, as you could imagine, bilateral discussion often takes longer time and requires greater efforts. Therefore, we have been encouraging banks to proactively reach out to their clients to discuss transition plans and amend derivative contracts in a timely manner. We are particularly pleased to note that steady progress has been made in this respect. As at end-December 2020, all banks in Hong Kong have already developed a communication plan for re-negotiating existing contracts with their clients, and a majority of them have completed or in the process of remediating relevant contracts.
- When we talk about coordination, another important pillar is regulatory coordination. Over the past years, there has been strong collaboration among regulators and central banks globally to discuss and address issues on benchmark transition. We at the HKMA are mindful of the importance of ensuring close coordination with our counterparts around the world.
- At the international level, we have been actively participating in various fora to contribute to the ongoing developments. In the context of the Financial Stability Board (FSB), we are a member of the Official Sector Steering Group which was established under the FSB to coordinate the work on interest rate benchmark reforms globally. We are also leading the work to conduct a follow-up survey to update the jurisdictional LIBOR exposures and understand how different economies are tackling the transition and supervisory challenges under the Standing Committee on Supervisory and Regulatory Cooperation.
- Closer to home, we are also actively taking part on the coordination work at the regional level. For example, I am currently serving as the chair of the Executives’ Meeting of East Asia-Pacific Central Banks’ (EMEAP) Working Group on Financial Markets (WGFM). Leveraging the capabilities and experience of ISDA, and having regard to the need for smooth IBOR transition in the EMEAP economies, it should be of mutual benefit to explore the development of a second ISDA IBOR Fallbacks protocol to cover fallbacks for IBORs that are not currently captured by the protocol launched last year.
- That should be conducive to facilitating a smooth benchmark transition in the region. The HKMA would be happy to facilitate further exchange of views and information between ISDA and EMEAP WGFM. I believe that this course of action resonates well with ISDA’s action plan, as it aligns with ISDA’s efforts to incorporate regional voices on an ongoing basis as evidenced by, for example, a panel focusing on “The Regional Approach” in the conference today.
- Let me now turn to the last “C”: Commitment. We all know there is no one-size-fits-all solution, and it is important for banks to consider their own needs and constraints when they tailor-make respective transition programs that work best for themselves. However, I would say that all these transition programs share one thing in common – that is the full commitment and support from the top management of the bank. These cover important aspects such as resources allocation, action plan formulation, and stakeholders engagement. The stakeholders include your staff internally and your business counterparties externally. You need to make sure that they both fully understand the importance of LIBOR transition and know what needs to be done to ensure the smooth transition.
- We fully appreciate the dynamic and evolving nature of this subject on LIBOR transition. We know that there are different moving parts, which may impact on your respective action plans along the way. This means that we all need to continue to monitor closely international and market developments. The IBA’s extension on the publication of key USD LIBOR settings until end-June 2023 is one such example. The extension would allow time for more legacy USD LIBOR contracts to mature, and give counterparties more time to renegotiate and amend USD LIBOR contracts maturing after end-June 2023. Banks should not relax their efforts in preparing themselves for the cessation of LIBOR.
- At the beginning of my remarks, I suggested the “3Cs” as a useful tool on what each entity could do individually to attain the important LIBOR transition goal. In closing, if you would allow me to add a final “C”, which is “Collective”. LIBOR transition is so complicated and involves so many parties in both bilateral and multilateral negotiation so that smooth transition will require collective and timely efforts from all of us to make it happen. With that, I encourage all of you to continue your collaborative efforts to prepare for the transition and make best use of ISDA Fallback Protocol and Supplement in these collaborative efforts.
- I hope all of you will have a fruitful and productive discussion today. Thank you.