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IBOR Transition #1: Interim Update On Money Market Rates Transition
Tuesday, 03 September 2019 This interim update summarizes the progress made by the US Federal Reserve in developing SOFR as a money market alternative to LIBOR.
In addition, this interim update also summarizes the potential impact on Singapore money Victor Yong market rates. Rates Strategist [email protected] We will provide further updates as and when more newsworthy details emerge from both Heng Koon How, CAIA global and local authorities. Head of Markets Strategy [email protected] The transition away from LIBOR has been steadily gathering pace. Earlier in June, Randal Quarles, the US Federal Reserve Vice Chairman in-charge of financial regulation, reiterated the FED’s commitment to spearhead the replacement of LIBOR by the end of 2021. Quarles was quoted as saying that “the transition should be happening in earnest” and warned that companies that continue to use LIBOR instead of SOFR will face increasing risks as they head into the transition.
Current State Of SOFR Development Spearheaded by the US Federal Reserve, the Secured Overnight Financing Rate (SOFR) is the preferred replacement for LIBOR. SOFR essentially measures the cost of borrowing cash overnight collateralized by U.S. Treasury securities in the repurchase agreement (repo) market. Given that the underlying US Treasuries repo market is highly liquid, with estimated daily transaction volume in excess of USD 900bn per day, the SOFR is deemed to be more resilient and transparent than LIBOR.
The US Federal Reserve via its New York office, took the very first step in April 2018 when it began publishing the SOFR. Thereafter, in May 2018, the CME launched and started trading of both the 1 month and 3 month SOFR futures. Over the past year, the product development and adoption rate in SOFR based markets have picked up pace, particularly across 2019.
LIBOR Transition Timeline
APRIL or in is in O R
MAY a n O R t r s
ULY anni a iss s irst O R R
OCTOBER YEAR E D B a s O R to Ban s not o a o ntin ist to s it IBORs 201 2021
201 2019 U E YEAR E D O R i nti i as I a n initions an r a nt or IBOR a o an in roto o
Source: AARC, UOB Global Economics & Markets Research
#1: Interim Update On Money Market Rates Transition Tuesday, 03 September 2019 1 I Page Parallel IBOR transition processes are also underway in other major global financial centers. The United Kingdom has identified SONIA (Sterling Overnight Index Average), Euro area has ESTER (Euro Short Term Rate), Switzerland has SARON (Swiss Average Overnight rate), and Japan has TONA (Tokyo Overnight Average rate).
Average daily volume for CME SOFR futures recorded a high of around 38.5k contracts in March 2019, and has averaged at around 27.5k contracts in 2Q 2019. Open interest for SOFR futures increased by around 67k contracts in August 2019, which was a 40% gain over the previous month and net increase in open interest was about evenly split between the 1M and 3M contracts. Traction in the SOFR futures market shows not only broadening interest in the new benchmark but also helps in the price discovery process of forward looking expectations for SOFR.
Average Open Interest SOFR Futures SOFR Linked FRN Issuances
Source: Bloomberg, UOB Global Economics & Markets Research Source: Bloomberg, UOB Global Economics & Markets Research
300 60
250 50
200 40
150 30 USD Bns 20 Contract ('000s) 100
50 10
0 0 01-Jul 01-Nov 01-Mar 01-Jul Jul-18 Nov-18 Mar-19 Jul-19 3M 1M 3Y 2Y 1Y < 1Y
In the month of August, SOFR-linked floating rate notes (FRN) issuance went above the USD 50bn markand there was around USD 239bn of notional outstanding at the end of that month. Issuance growth has mainly been led by papers with up to 1 year maturity, but the longer maturities have also been gaining some traction in the past 3 months. The overall trend is positive and encouraging although SOFR based markets still remain but a fraction of the LIBOR based markets.
Overnight SOFR rate tracks both Fed Funds Effective Rate as well as overnight LIBOR rates, albeit with more variability. In addition, overnight SOFR rate also displays a more pronounced upward drift into month end as compared to Fed Funds Effective Rate and overnight LIBOR rates.
Overnight Interest Rates
Source: Bloomberg, UOB Global Economics & Markets Research
3.30 3.10 2.90 2.70 2.50 % 2.30 2.10 1.90 1.70 1.50 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 SOFR LIBOR Fed Funds
#1: Interim Update On Money Market Rates Transition Tuesday, 03 September 2019 2 I Page SOFR Development For The Rest Of 2019 SOFR development as the market liquidity benchmark is governed by the Alternative Reference Rates Committee (ARRC), which is convened by the US Federal Reserve’s New York office. The ARRC has in April 2019 published a “User’s Guide to SOFR”. Subsequent development for the rest of 2019 is geared towards driving growth in SOFR-linked FRNs, deepening liquidity in SOFR derivatives, and launching SOFR-linked loans and securities. In addition, plans are also afoot to update the ISDA calculation and definition for SOFR.
Impact On SG Money Market Rates Singapore has 2 sets of benchmark money market rates; SOR and SIBOR. Both rates are published by the ABS Benchmarks Administration Co (ABS Co), a fully owned subsidiary of the Association of Banks in Singapore (ABS). According to the ABS website, the Singapore dollar SOR (Singapore Swap Offer Rate) is defined as the synthetic rate for deposits in SGD, which represents the effective cost of borrowing the SGD synthetically by borrowing USD for the same maturity, and swap out the USD in return for the SGD.
While the SIBOR stands for Singapore Interbank Offered Rates and is a polled rate by various contributor banks that contribute the rate at which it could borrow funds were it to do so by asking for and accepting the interbank offers in reasonable market size, just prior to 11 am Singapore time each business day. Overall, the former is more relevant for derivative transactions, FX/ currency swaps, and bond issuances, while the latter is more commonly seen in mortgages and commercial lending.
The transition from LIBOR to SOFR will have a direct impact on SOR since LIBOR rates are used as an input into deriving SORs. Since LIBOR is slated to be replaced by SOFR in 2021 and there may still be outstanding issues in reconciling between SOFR and LIBOR, such as the treatment of term premiums, MAS has convened a steering committee to pave the way for a transition away from SOR and into the Singapore Overnight Rate Average (SORA). We go into more detail on SORA in our publication “Rates Strategy: Transitioning From SOR To SORA”.
Objectively, SIBOR is not directly affected by the transition to SOFR because it is a polled rate based on the cost of domestic SGD interbank lending. Nonetheless, Singapore authorities have since 2013 started the process of enhancing SIBOR. In Singapore, this process to enhance SIBOR is governed by the ABS Co and the Singapore Foreign Exchange Markets Committee.Along the lines of the 2013 IOSCO Principles for Financial Benchmarks, the process for determining SIBORs has been enhanced with the adoption of a waterfall methodology (key feature being a wider catchment for transaction-based rate submission) as well as a discontinuation of the 12M tenor. Migration into the enhanced SIBOR process is undergoing transitional testing in 2H 2019, and the target is for implementation between end 2019 and early 2020.
For more details of the above mentioned regulations and guidelines, kindly refer to the appendix below.
Appendix
1. SOFR Futures homepage, by CME Group Read more 2. “A User’s Guide to SOFR” April 2019 by Alternative Reference Rate Committee (ARRC) Read more 3. SIBOR and SOR homepage, by ABS Co Read more 4. “Consultation Paper on the Evolution of SIBOR”, Dec 2017 by ABS Bechmarks Administration and Singapore Foreign Exchange Market Committee Read more 5. “Response to Feedback Received from the Consultation Paper on Evolution of Sibor”,July 2018 by ABS Benchmarks Administration and Singapore Foreign Exchange Market Committee Read more
#1: Interim Update On Money Market Rates Transition Tuesday, 03 September 2019 3 I Page Recent Publications India: Growth Decelerated To The Slowest In 6 Years, 02 Sep 2019 China: Mixed Signals From August Manufacturing PMIs, 02 Sep 2019 The Central Bank Watch, 02 Sep 2019 Infographic: Understanding PBoC’s Revamped Loan Prime Rate, 30 Aug 2019 South Korea: Bank Of Korea Stays Put In August, 30 Aug 2019 Month In Review, 29 Aug 2019 UK: Queen Approves PM Boris Johnson’s Request To Suspend Parliament, 29 Aug 2019 Indonesia: Unleashing The Power Of Consuming Class, 28 Aug 2019 Malaysia: Further Gains In 1H19 Investment Approvals, 28 Aug 2019 Rates Strategy: Lowering Our Rates Outlook Based On Suboptimal Outcomes, 27 Aug 2019
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