Why Asia needs to talk about SOFR

Focus on local benchmark reform is “distracting” Asia’s preparations for the end of USD Libor

Libor transition in Asia is generally viewed by observing the progress of the local currency benchmarks.

In Japan, the transition away from yen Libor has been slow from a product perspective, but the country is the first to select a vendor to build a term version of its chosen alternative risk-free rate – the Tokyo overnight average rate.

In countries that use benchmarks with embedded US dollar Libor dependencies, such as Singapore’s swap offered rate, efforts have been made to promote the use of an overnight version of the rate, with cleared swaps and trading kicking off this year, along with floating rate note issuance.

Other countries, such as Hong Kong, have also made progress in promoting overnight versions of their traditional term fixings.

But while progress has been made on local benchmark transition, some participants are starting to worry that domestic firms’ exposures to US dollar Libor are being ignored.

“We do have local markets to take care of, and those discussions are not completed,” says a fixed income head at a Hong Kong-based asset management firm. “You could argue that this is distracting the discussion about the transition to the secured overnight financing rate [SOFR].”

The ubiquity of the world’s reserve currency in local Asian markets makes the end of USD Libor and the benchmark’s replacement by SOFR particularly important for the region.

For example, tens of billions of dollars of floating rate notes linked to USD Libor are issued in Asia every year – a trend that has shown no sign of abating in 2020, despite the benchmark’s very uncertain future.

Examples of floaters linked to SOFR remain few and far between. Besides the Bank of China’s Macau branch, which piloted a SOFR note issuance in October last year, the only Asian institutions to issue floaters linked to the benchmark are Westpac and Sumitomo Mitsui Banking Corporation.

The absence of further trial issuance linked to the new benchmark creates a couple of key risks for issuers and investors in Asia to address ahead of Libor’s demise. 

You could argue that this is distracting the discussion about the transition to SOFR
Fixed income head at a Hong Kong-based asset management firm

First, SOFR is based on secured overnight transactions that reflect funding conditions in Treasury repo markets, and as such it can behave differently from more familiar unsecured rates, as volatility in the rate at quarter- and year-ends has shown. An absence of pilot issuance in the region makes it harder for issuers and investors to develop an understanding of that behaviour prior to Libor’s likely cessation.

Second is the issue of legacy contracts. There continues to be a great deal of legal uncertainty around the fate of legacy USD floaters issued by local Asian firms once Libor ceases to be. In theory, bondholders have to be rounded up and consent sought if fallback rates are to be inserted into these products, but it’s not clear how much progress is being made.

Without those changes, the floating rate products may turn into fixed when Libor stops printing, meaning the risks associated with issuing and investing in these instruments grow bigger every day.

There is now possibly less than 18 months before the death of USD Libor. Institutions across the region must pick up the pace to prepare for this unprecedented event. The clock is ticking.

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