Hong Kong banks face deadlines to migrate US$205 billion of contracts tied to scandal-ridden Libor with no alternative rates in place

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Hong Kong banks must step up efforts to migrate legacy contracts tied to the scandal-ridden London Interbank Offered Rate (Libor) benchmark as more than HK$1.6 trillion (US$205 billion) of assets, liabilities and derivatives will mature without any fallback.

Lenders will have about six weeks to immediately transition about HK$201 billion of loans and derivatives into a new reference rate before the first of two deadlines arrives, the Hong Kong Monetary Authority (HKMA) said. That is when two of the seven dollar-Libor rates - the 1-week and 2-month tenors - will be discontinued on December 31. Five other tenors will be ended by June 2023.

This batch represents part of the amount the city’s de facto central bank highlighted as one of the pressure points in the transition plan. Banks had HK$5.5 trillion of assets and liabilities and HK$34.9 trillion in derivative contracts tied to Libor on September 30, the HKMA said. Of these, about 21 per cent of the assets, 17 per cent of the liabilities and 2 per cent of the derivatives would mature after Libor’s cessation dates and did not have adequate fallback, it added on its website.

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“There isn’t much time left, so experts within corporate treasury practices should [also] step up their efforts to push forward with the benchmark transition,” Arthur Yuen, deputy chief executive of the HKMA, said, referring to the December 31 deadline.

The central bank has been preparing banks for Libor transition since early 2019, but one of the biggest challenges impeding adoption of the new US dollar benchmark, the Secured Overnight Financing Rate (SOFR), has been from corporate borrowers who remain unfamiliar with the new benchmark, he added.

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Libor, particularly when used as a reference rate in US dollar-denominated transactions, has been an important benchmark driving lending, investing and hedging activities in Hong Kong for many years, accounting for 26 per cent and 8 per cent of the banking system’s total assets and liabilities denominated in foreign currencies respectively.

The HK$201 billion legacy Libor contracts account for less than 1 per cent of the banking sector’s total Libor exposures in the local financial market.

Another 3.7 per cent, or about HK$1.5 trillion, will face the final deadline on June 30, 2023 when five remaining tenors from overnight to 12 months will cease.

Companies are also taking a wait-and-see approach with the switch, as they are concerned that a change to the new SOFR benchmark would give them a less favourable funding rate due to its different calculation mechanism, Yuen said.

The risk is looming, as contracts that reference Libor could be subject to legal disputes if companies do not reach an agreement with their banks on a replacement rate before Libor becomes unavailable.

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“If some of these contracts cannot reach a remediation, then there is a legal issue on what should be the pricing benchmark, as most contracts have embedded clauses for arbitration,” said Yuen.

Global regulators have decided to discontinue Libor starting from the end of this year after the Libor scandal in 2012, where several banks were found to have rigged it for profit. In Hong Kong, the HKMA has required banks to stop issuing Libor-linked contracts by the end of this year.

There is currently no plan in the city to discontinue the Hong Kong Interbank Offered Rate (Hibor), which is often used as a benchmark for home loans.

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However, to conform with the global trend in using rates that are based on more active overnight lending benchmarks, the Treasury Markets Association – an industry body of bankers, money brokers and corporate treasurers – has identified a new benchmark called Hong Kong Overnight Index Average (Honia) as an alternative gauge for Hibor, for banks and borrowers to consider.

To promote wider adoption of Honia, the HKMA will on Wednesday tender a total HK$1 billion one-year floating rate note indexed to Honia, which will pay quarterly interest. Many banks in Hong Kong have also started offering contracts referencing Honia.

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