End of Libor will see replacement of SOR benchmark

End of Libor will see replacement of SOR benchmark

Committee to oversee rate benchmark transition from SGD Swap Offer Rate (SOR) to S'pore Overnight Rate Average (SORA)

Sat, Aug 31, 2019

JAMIE LEE
RACHEL MUI


SINGAPORE will transition from the use of the Sing-dollar Swap Offer Rate (SOR) to the Singapore Overnight Rate Average (SORA) over the next two years, as the scandal-tainted Libor is due to meet its end after 2021.

The SOR - a benchmark used to price derivatives and business loans here - will be impacted given the demise of Libor, as the Singapore rates benchmark uses the US-dollar (USD) Libor in its computation.

The SOR represents an implied interest rate on a foreign exchange (FX)-swap basis, as calculated from actual transactions in the USD/SGD FX swap market.

The Libor - short for the London Interbank Offered Rate - has been used as a reference rate for loans and derivatives. But the UK Financial Conduct Authority in 2017 said it would abandon Libor, the interest-rate benchmark on which trillions of transactions globally are priced.

This followed the rigging scandal in 2012, which led to some US$9 billion in fines levied on banks for attempting to manipulate the Libor, rocking the credibility of the major benchmark.

The manipulation concerns ran alongside the problem that while Libor is the dominant benchmark for pricing of loans and derivatives, it has not reflected many actual transactions in the post-crisis period.

The situation left Libor vulnerable to the manipulation that occurred in 2012.

Other major markets, including the US, UK, and Japan, have selected their alternative rates as well.

While it is unclear the exact exposure of the corporate loans and derivatives held by Singapore banks that are priced using SOR and need to be transitioned for pricing against SORA, market observers had said that the concern is less likely over an outsized exposure, but that of ensuring an orderly transition.

Koh Ching Ching, OCBC's head of group brand and communications, said the bank will ensure a "smooth transition for our counterparties and customers as we replace SOR with SORA".

In a consultation paper by the Association of Banks in Singapore and the Singapore Foreign Exchange Market Committee (ABS-SFEMC) on Friday, they said the SORA was found to be the "most robust and suitable alternative", as it is a transaction-based benchmark underpinned by a deep and liquid overnight funding market.

The SORA is the average rate of unsecured overnight interbank SGD transactions brokered in Singapore. The rate is published daily on the MAS website at around 6:30 pm currently and has been accessible at no charge since July 1, 2005.

ABS-SFEMC said that the publication of SORA since July 2005 provides "a long historical time series which facilitates analysis for risk management, and pricing purposes by market participants".

"Importantly, the choice of SORA as the reference benchmark for SGD interest rate derivatives is also aligned with the global shift for derivatives markets to reference near risk-free rates," it said.

To add, the compounded average SORA has a stronger correlation to the Singapore's own interbank benchmark (Sibor) than SOR.

The weak correlation between SOR and Sibor currently undermines the use of SOR-based interest rate derivatives for hedging of Sibor exposures.

"The transition to SORA-based derivatives may provide market participants with a better instrument for hedging Sibor-based exposures as compared to existing SOR-based derivatives."

For SGD cash products such as loans that reference SOR, ABS-SFEMC said that these products can continue to reference various interest rate benchmarks, including Sibor, SORA, or banks' internal funding rates.

"This is consistent with the current industry practice where SGD cash products use a broad range of interest rate benchmarks," it said.

Interest-rate derivatives priced in Sing-dollar reference the SOR. Over the medium term, ABS-SFEMC said it expects that SORA will be used directly in SGD derivatives. It added that having more SORA-based derivatives will in turn lift the attractiveness of using SORA and term-SORA in cash markets later. Term-SORA refers to forward-looking interest rate benchmarks based on derivatives referencing SORA.

The ABS-SFEMC considered, and then rejected, two other options.

The first option was to reform SOR, but there was broad consensus within ABS-SFEMC to stop relying on a US interest rate benchmark to compute a key SGD interest rate benchmark. ABS-SFEMC wanted to explore the adoption of a SGD benchmark which would be more reflective of domestic funding conditions, it said.

The second option was to enhance Sibor, but the committee noted the "significant risks" in concentrating SGD derivatives markets on a single Sibor benchmark. While there are ongoing moves to improve Sibor by anchoring rate submissions to eligible wholesale funding transactions, the volume of these transactions is generally much smaller than that of transactions in overnight interbank money markets, which underpins SORA.

MAS has set up a steering committee to drive the transition. It will be chaired by Samuel Tsien, OCBC's group CEO who is also the current chairman of ABS.

Among other things, the committee will be responsible for providing strategic direction on industry proposals to develop new products and markets based on SORA. It will also engage with stakeholders to seek feedback and raise awareness on issues related to the transition from SOR to SORA, MAS said.

The committee will comprise of senior representatives from key banks in Singapore, relevant industry associations, and the MAS.

Andrew Ng, head of treasury and markets at DBS, said the transition to SORA is a "complex task".

"The industry-wide collaborative approach... will ensure that the derivative market, cash market and businesses overseeing corporate and consumer loans are well-prepared and informed about the mechanism of the new benchmark."

Gary Mellody, EY Asean Financial Services Risk Advisory Leader, said that banks are "well underway" with their interbank lending rate ( IBOR) transition programmes.

"The timelines proposed by MAS (Monetary Authority of Singapore) seem realistic, albeit the overall timeliness and broader industry implications associated with the IBOR transition remain challenging."