By Pan Yue
Bank of China deserves plaudits for trying to test the waters. The Chinese lender’s Macau branch issued Asia’s first public bond benchmarked against the secured overnight financing rate (Sofr), the most likely alternative to Libor in the dollar market, in October.
A senior banker at BOC Hong Kong said that it had already done three transactions linked to Sofr, including a commercial paper issue, a corporate loan and a deposit from a private banking client.
But the state-owned Chinese lender cannot prepare the region’s banking system for the seismic shift away from Libor without help. More needs to be done – and it needs to done urgently. The loan market is the sensible place to start.
Although Asia’s bond market will undoubtedly stumble during the transition away from Libor, the nature of the bond market – pitting myriad issuers and investors against each other – means it is hard to address the big, difficult questions.
The loan market, where relationships are more collegiate and lasting in nature, allows more open discussion.
The Asia Pacific Loan Market Association (APLMA), has taken only baby steps so far. It has added a clause to its loan template stating that if a screen rate is unavailable, it can be replaced by another reference rate with the consent of the borrower and the majority of lenders.
This is clearly not going to be enough. First, the clause is vague. It does not specify which new rate will be used when Libor is discontinued, creating potential headaches for bankers and borrowers if they do need to start negotiating a new reference rate. Although Sofr is most likely to become the alternative to dollar Libor, there are questions over whether to use average Sofr, simple daily Sofr or compounded Sofr. In addition, the Alternative Reference Rates Committee is also in discussion to develop a Sofr term rate before the end of 2021.
More time spent on identifying the ideal replacement, starting now, will reduce problems in the future
Second, it fails to acknowledge that serious negotiation around margins and fees will need to accompany the shift to a new rate. For instance, Sofr is generally lower than Libor, implying higher margins. And since Libor may be replaced by several rates instead of one, banks will not have the same sort of natural hedge against rate fluctuations: that should be reflected in fees.
Third, the clause doesn’t offer a solution if the borrower and the majority of lenders cannot come to an agreement, or if the lending group is split between two different reference rates. More time spent on identifying the ideal replacement, starting now, will reduce problems in the future.
In Asia, the development of Honia (HK dollar overnight index average), the alternative for Hibor, is also limited. A committee has been formed with bankers and a representative from the Hong Kong Monetary Authority to discuss the issue, but little progress has been made.
There are some clues as to what a solution will look like. The London-based Loan Market Association drafted compounded Sofr-based US dollar term loan and revolving facilities agreements templates in September. In the same month, it also published a draft reference rate selection agreement, which can be used when a loan is transitioning to alternative reference rates.
Asian banks could easily follow suit. The APLMA could also provide a similar template for Honia. However, so far, it has not come up with any Asia-focused drafts, apart from publishing the same documents from the LMA on its own website in November.
It also seems likely that a wide net will need to be cast before any solution can be identified. The main reason banks are reluctant to move away from Libor for syndicated deals is the lack of obvious demand. That means any conversation about the next reference rate should include those smaller institutions who rarely drive deals but offer strong support in syndication – smaller Taiwanese banks being the obvious example.
It might appear that there is plenty of time. Bankers may be tempted to leave any solution to the last minute, playing a game of chicken with the regulator in the hope that the end of Libor could be delayed. But that logic is dangerous for an essential component of global financing markets.
First published on GlobalCapital.com