Hong Kong Considering Shift to ‘Nearly Risk-Free’ Benchmark Rate

Hong Kong is planning benchmark interest rate reform, specifically the gradual adoption of a “nearly risk-free” rate based on actual transaction data — rather than estimates made by banks — as the new alternative reference rate to the Hong Kong interbank offered rate (Hibor).

Interbank offered rates are the basic interest rates at which banks offer each other loans, and they are often used as a reference rate for the interest on other kinds of loans.

The Hong Kong Monetary Authority (HKMA) said that while there are no plans at present to discontinue Hibor, it has an “obligation to put in place an alternative reference rate as a contingent fall-back,” according to an HKMA document that’s set to reach Hong Kong’s Legislative Council next week. This means that Hong Kong may soon see the coexistence of two local reference rates.

Currently, banks in Hong Kong can use Hibor or another reference rate benchmark — Libor. Both Hibor and Libor are calculated based on a survey of the rates at which major banks estimate they are offering. However, after a scandal at the start of the decade in which it was discovered the banks were manipulating Libor, the U.K. Financial Conduct Authority indicated in 2017 that it will only continue to work with banks to sustain the rate until the end of 2021. It also warned financial institutions that they must prepare for the transition to alternative reference rates.

Several major financial markets are pushing for reform of reference rates, according to a November report from the Financial Stability Board (FSB), an international body that monitors the global financial system. The FSB itself suggested in 2014 that major markets should reform interest rate benchmarks such as key interbank offered rates and develop alternative “nearly risk-free benchmark rates” based on actual transaction data.

These suggestions came not only in the wake of the Libor scandal, but also together with the post-financial crisis decline in liquidity in interbank unsecured funding markets, the FSB said in the report. The U.K. and the U.S. banking systems have respectively planned to use the Sterling Overnight Index Average and the Secured Overnight Financing Rate — both of which are based on transaction data — to replace Libor.

“The HKMA is closely monitoring international developments related to Libor reform. Recently, a working group has been established under TMA (Treasury Market Association) to raise market awareness of the Libor discontinuation and work with the local financial industry to get ready for the transition,” the HKMA said in the document.

The members of TMA, an industry association that develops codes and standards for the Hong Kong treasury markets, have been discussing the adoption as an alternative reference rate of the HKD Overnight Index Average, a benchmark rate based on actual transaction data, the HKMA said in the document.

“The market (in Hong Kong) will likely continue to adopt Hibor until the authorities come up with a proper transition mechanism,” said Ryan Lam, head of research of Shanghai Commercial Bank. He said that although there has been no fraud associated with Hibor, the current interbank interest rate mechanism generally has loopholes, which is why the regulatory authorities are looking to reform the system.

The TMA will conduct a consultation in the first quarter of 2019, according to the document.

Contact reporter Timmy Shen (hongmingshen@caixin.com)