Evolution of benchmarks: Update on UK, EU and Singapore

Regulatory update on reforming major interest rate benchmarks following the scandals involving the manipulation of financial benchmarks.

With the unfolding of the financial scandals involving the manipulation of financial benchmarks, and the subsequent publication by the Financial Stability Board Official Sector Steering Group of its report on reforming major interest rate benchmarks, there has since been various regulatory developments and reforms introduced, notably in the UK, EU and Singapore.

Position in the UK

The CEO of the UK Financial Conduct Authority (FCA) has stated that FCA, which currently regulates the London Interbank Offered Rate (LIBOR), will no longer ask or require banks to submit LIBOR rates after end-2021. There is a clear effort to transition away from the current use of LIBOR in an orderly manner.

The market is presently looking for alternative rates and there are ongoing discussions on potentially using Sterling Overnight Index Average (SONIA) or Secured Overnight Financing Rate (SOFR) as replacement rates. Neither appears to be entirely appropriate for use in the loans market for various reasons, including the fact that these rates are overnight backward looking rates whereas pricing for loans is typically based on tenor-specific forward-looking rates.

The industry body for syndicated loans, the Loan Market Association (LMA), has expressed the view that there should be a market-led solution with a consistent approach across all leading financial industry bodies. Until the alternative rate is identified, LMA template documents cannot be updated definitively but there is likely to be new language proposed to facilitate to transition to a new rate pending identification on that rate.

Position in the EU

The EU Benchmarks Regulation has now entered into force. Most of the new rules will not apply until 01 January 2018 but some provisions relating to critical benchmarks are already in effect.

The Regulation aims to reduce conflicts of interests and the risk of manipulation arising and to restore public confidence in the accuracy and integrity of financial benchmarks. The Regulation seeks to address potential issues at each stage of the benchmark process. In particular, the Regulation will introduce requirements which are intended to improve the quality of input data from benchmark contributors and the methodologies employed by benchmark administrators to compile the benchmark. The Regulation also introduces improved governance requirements and controls over the benchmark process, which are intended to ensure that benchmark administrators avoid conflicts of interest, or at least take steps to manage them adequately. EU regulated entities that use a benchmark will be required to produce and maintain robust written plans setting out the actions that they would take in the event that a benchmark materially changes or ceases to be provided. Where feasible, such plans should specify an alternative benchmark that could be used as a substitute. EU regulated entities are required to provide these plans, upon request, to their regulators and also to reflect them in their contractual documentation with their clients.

Broadly, under the transitional provisions applicable to the Regulation, existing benchmarks may continue to be used by EU regulated entities until 01 January 2020. However, it is also important to note that contributors, administrators and users of benchmarks will have some new obligations under the EU Benchmarks Regulation from 01 January 2018.

Position in Singapore

ABS Benchmarks Administration Co Pte Ltd, which administers the Singapore Interbank Offered Rate (SIBOR), together with the Singapore Foreign Exchange Market Committee published a consultation paper in December 2017. One of the main proposals of this consultation paper is to adopt a new waterfall methodology in computing SIBOR. The main change from the current approach is the proposal to reference a broader set of banks’ borrowing transactions beyond those in the interbank market.

Waterfall Level Data Type  Features
Level 1 (highest priority) Transactions in underlying market The Volume Weighted Average Price (VWAP) of a panel bank’s unsecured interbank and wholesale funding transactions.
Level 2 Transactions in related markets Adjustment of previous level 1 or 2 submissions with related transaction data.
Level 3 (lowest priority) Expert Judgement Internally documented methodology for deriving rate submissions, subject to appropriate governance and accountability controls.

It is proposed that this methodology will provide greater clarity and additional guidance on the type of transactions in underlying markets that can be included, and how related market transactions can be used to anchor submissions. This new waterfall methodology expands the funding sources taken into consideration in computing SIBOR, strengthens SIBOR’s reliance on transaction data, and should also provide more explicit guidance to panel banks, to ensure consistency in practices across the panel banks.

In addition, other proposals include:

  • reviewing the tenors of published SIBOR rates
  • changing the trimming methodology from removing outliers at the top and bottom quartiles to taking the average of the median group of panel banks’ submissions, and
  • publishing the proportion of submission inputs (ie level 1, level 2, and level 3) for each benchmark tenor periodically.

The good news for market participants is that the current proposal is to ensure a seamless transition path for SIBOR. The name of the benchmark would remain as “SIBOR” and the rate would continue to be published on the same data vendor pages.

What next?

From a loan operations perspective, banks and borrowers should review existing loan documentation to ensure that there are sufficient safeguards in place to ensure that the loans can continue to be administered even if the relevant benchmarks are no longer available. This includes considering what fallback calculation mechanics there are and the steps and, in the context of syndicated loans, the relevant consent levels required in triggering the fallback mechanisms.

From a regulatory perspective, panel banks should be examining the obligations and liabilities attached to the continued provision of reference rates, and how best to manage those risks and responsibilities.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.