What is IBOR? Why is there a need for IBOR to transition to alternative benchmark rates?

Interbank Offered Rates (“IBORs”), in particular, the London Interbank Offered Rates (“LIBORs”) are financial interest rate benchmarks used in various financial contracts, including but not limited to loan, derivative and bond documentation.

LIBOR is currently set for five currencies (CHF, EUR, GBP, JPY and USD) and seven tenors. It is based on submissions from panel banks, which indicate the rate at which they could borrow from other banks.

The need to transition from IBORs arises from the global reform efforts to improve the robustness and integrity of financial benchmarks. For general background regarding benchmarks transition from LIBOR, please refer to IOSCO’s Statement on Communication and Outreach to Inform Relevant Stakeholders Regarding Benchmarks Transition dated 31 July 2019.

LIBOR is often calculated by reference to “expert judgement” by panel banks. As part of the global benchmark reforms, the UK Financial Conduct Authority ("FCA"), the supervisory authority of LIBOR, has stated that it will no longer compel banks to submit rates used for the calculation of LIBOR after 31 December 2021. This means that LIBOR is expected to be discontinued after end-2021. As a result, the FCA and other regulators are requiring banks to plan for the discontinuation of LIBOR by the end of 2021 and are encouraging market participants to transition to alternative benchmark rates.

Which rates are likely to replace LIBOR?

Alternative benchmark rates have been identified by the respective jurisdictions to replace LIBORs and are set out in the table below. These risk free rates ("RFRs") are all overnight interest rate benchmarks, and are based on actual transactions which may be secured or unsecured.

How does the alternative benchmarks (ie RFRs) differ from LIBOR?

The alternative benchmarks (ie RFRs) differ from LIBOR in the following ways:

1. RFRs are overnight rates (published retrospectively) while LIBOR is a forward looking term rate (published prospectively).
2. Payments referencing RFRs are only known (in arrears) at the end of accrual period while that referencing LIBOR are known (upfront) at the start of accrual period.
3. Unlike LIBOR, RFR contains little or no credit risk or term premium.

What are the Singapore benchmark rates that will be affected?

As USD LIBOR is expected to be discontinued after 31 December 2021 and given that Singapore’s Swap Offer Rate (SOR) utilises the USD LIBOR in its computation, the cessation of USD LIBOR will directly affect the sustainability of SOR.

The Association of Banks in Singapore and Singapore Foreign Exchange Market Committee ("ABS-SFEMC") have identified Singapore Overnight Rate Average (SORA) as the most suitable interest rate benchmark to replace SOR. On 30 August 2019, ABS-SFEMC released a consultation report that identified SORA as the alternative interest rate benchmark to SOR, and set out a roadmap for this transition. The consultation closed on 31 October 2019, and the response paper to the consultation was released in March 2020. Overall, there was broad support for the proposed transition approach to SORA, with many respondents noting that this was aligned with the global transition from LIBOR to RFR.

SORA has been published by the Monetary Authority of Singapore ("MAS") since 2005, and is a robust benchmark that is underpinned by a deep and liquid overnight interbank funding market.

To ensure a smooth transition from SOR to SORA, MAS has set up an industry-led Steering Committee for SOR Transition to SORA ("SC-STS") comprising senior representatives from key banks, relevant industry associations and MAS. SC-STS will provide strategic direction on industry proposals to develop new products and markets based on SORA, and support this transition process in the coming quarters.

Click here for the list of SC-STS members.

What is SORA? Where can I get data on this benchmark?

SORA is published daily by the MAS and is a robust benchmark underpinned by a deep and liquid overnight interbank funding market. It is published on the MAS website daily and has been accessible at no charge since 1 July 2005. The historical series can be downloaded from the MAS website.

Why did ABS-SFEMC not replace SOR with SIBOR which will be enhanced soon?

While SIBOR is well understood by the market, ABS-SFEMC assessed that there were significant risks in concentrating all SGD derivatives and cash market products on the SIBOR benchmark.

First, the volume of transactions underpinning SIBOR is significantly smaller than the volume of transactions in the overnight interbank funding markets which underpins SORA.

Second, even with the proposed measures to enhance SIBOR by anchoring panel submissions to eligible wholesale funding transactions, the enhanced SIBOR would be vulnerable to a discontinuation of USD LIBOR as it relies on SOR as an input in its waterfall methodology.

Third, given the direction of global benchmark reforms, structural shifts in banks’ key sources of funding, and the move to have derivatives markets reference overnight interest rate benchmarks, ABS-SFEMC viewed that adopting SORA as the benchmark for the SGD derivatives market would align the SGD market with international conventions and best practices. This will support the continued participation of global institutions and investors in the SGD market.

Is the usage of overnight interest rates common in the financial markets? How does SORA compare to SOR? Is it more volatile?

The use of overnight interest rate benchmarks in financial products is increasing in other major currency areas. These include futures and Overnight Indexed Swaps (OIS) referencing SOFR and SONIA. Market participants that have experience with such products should find the adoption of SORA-based derivatives to be relatively easy.

Globally, the use of overnight interest rate benchmarks (i.e. risk-free rates or RFR) has been gaining traction in many key jurisdictions, including the UK and US. While there were some initial concerns around the volatility of SORA on a daily basis, it was recognised that financial products which reference overnight rates typically use an average rate over a period, and not a single day’s rate. For example, a SGD OIS or loan contract could be settled against the 3-month or 6-month compounded average SORA. As seen in the chart below, this compounded average SORA which financial contracts would reference, is more stable than the 6-month SOR, which most SGD derivatives currently reference.

There are also several key benefits in using compounded SORA in cash markets:

• Such rates constructed from deep underlying overnight funding markets, are very robust and not susceptible to manipulation.
• The averaging effect of compounded SORA rates would result in more stable rates, compared to forward-looking term rates, which are exposed to idiosyncratic market factors on a single day’s fixing, such as quarter/year-end volatility.
• With the SORA derivatives market moving towards compounded rates (in line with derivatives markets globally), having cash products pegged to compounded rates allows for more effective hedging as the basis risk between cash and derivatives markets is minimised.

Which product types will be affected by the transition?

Any product using LIBOR and SOR as a reference rate will be affected. This could include derivatives, cash market products (e.g. business loans, syndicated loans, retail mortgages, floating rate notes, perpetual bonds and banks’ capital instruments), as well as outstanding debt securities with resettable interest rate features referencing LIBOR and SOR.