Risks related to benchmarks
This document is provided by Standard Chartered Bank and its affiliates (SCB) for general information only. This document does not supersede any specific product risk disclosures. Whilst SCB endeavours to ensure the information in this note is current, SCB cannot guarantee its accuracy in this rapidly evolving area. In addition, SCB does not represent that the risks highlighted in this document are complete. You should exercise your own independent judgment and seek your own professional advice, where necessary, with respect to the risks and consequences of entering into any financial contracts or purchasing any financial instruments that include a reference to financial indices and reference rates (Benchmarks).
General Risks Related to the use of Benchmarks
Benchmarks, such as Interbank Offered Rates (IBORs) and in particular, the London Interbank Offer Rate (LIBOR), have been commonly used to determine amounts payable under various financial contracts and their value.
Benchmarks have been the subject of ongoing scrutiny, guidance and reforms at national and international level, including the following:
- The Board of the International Organization of Securities Commissions (IOSCO) has published principles and statements in relation to Benchmarks since 2013.
- The Financial Stability Board (FSB) and other regulators (including the FCA) have encouraged the identification and use of alternative risk-free (or near risk-free) rates (RFRs) for certain interest rate Benchmarks. Some regulators have introduced new laws and regulations, such as the European Benchmark Regulation (Regulation (EU) 2016/1011) (BMR) in the European Union (EU), that govern the administration, contribution to and use of Benchmarks. Although the United Kingdom (UK) officially left the EU on 31 January 2020, the BMR will continue to apply in the UK until the end of the implementation period on 31 December 2020. The UK Government has agreed to ‘onshore’ the substantive BMR provisions to ensure that these continue to operate effectively in the UK following the UK’s exit from the EU.
- The UK government, the EU Commission and the Alternative Reference Rates Committee (ARRC) in New York have proposed various legislative powers to deal with certain contracts that cannot readily transition from LIBOR. Whilst it is intended that these powers will only be used where necessary, the exact extent of the powers, the circumstances in which they may be exercised and the scope of application to different types of contracts is currently uncertain but it should be noted that the exercise of such powers may result in the prescription of a mandatory fallback rate to the relevant Benchmark. There is a risk that such fallback rates may perform differently to existing Benchmarks and/or other replacement rates.
Arising from these Benchmark reforms, one or more of the following have occurred (or may occur in the future):
- Some Benchmarks, including their methodology, may change to ensure compliance with applicable laws or standards.
- It may no longer be permissible or practicable for some market participants to enter into, or remain in, financial contracts or financial instruments which reference some Benchmarks, because such Benchmarks (or their administrator) may not comply with applicable law, regulations or standards.
- Some Benchmarks may perform differently if and when some contributors cease to provide quotations or transaction data used to determine the Benchmarks.
- Some Benchmarks, such as LIBOR, may cease permanently or be determined in a very different way than was previously the case.
- Some Benchmarks may be deemed to be unrepresentative by certain regulators or governing bodies.
- RFRs may behave materially differently to existing Benchmarks.
- Uncertainty as to the interest rate Benchmarks that will apply in the long-term, together with attendant legal and operational uncertainty, may affect the liquidity in certain financial instruments. Some financial instruments that reference existing interest rate Benchmarks may be valued differently in the secondary market compared to substantially similar financial instruments that reference RFRs.
Regulators (notably from the United Kingdom and the United States) have made statements that the availability of LIBOR cannot be guaranteed after the end of 2021, and that market participants must prepare for the cessation of LIBOR. It is not possible to predict whether, and to what extent, panel banks will continue to provide LIBOR submissions to the administrator going forward. This may cause LIBOR to perform differently than it did in the past and may have other consequences which cannot be predicted. There has been, and continues to be, much industry consultation among market participants, trade associations and regulators to enhance contractual robustness to deal with potential changes to, or cessation of, relevant Benchmarks.
Contractual fallback solutions to the unavailability of an existing Benchmark of the type traditionally found in cash or derivative products (e.g. lender(s) cost of funding or reference bank quotations) may work for a temporary unavailability of a Benchmark but where a Benchmark permanently ceases or is otherwise disrupted it may (depending on market circumstances at the time) not operate as intended and it may be unclear and uncertain what rate the instrument would reference as a result of that process. As a result of this lack of clarity and certainty, there is no way to know at this time whether you would be disadvantaged economically, and you are encouraged to obtain independent advice on your position. Timing for any discontinuation of certain Benchmarks may vary across different currencies and tenors and may differ from the discontinuation of other Benchmarks.
For Benchmarks that may cease, such as LIBOR, certain regulators have proposed that the smoothest transition is one in which new contracts are written and existing contracts amended to reference rates other than LIBOR. However, it is acknowledged that markets and products referencing RFRs continue to develop and there are currently differing levels of liquidity in each of the markets for RFRs.
During the transition period it is expected that the terms of financial contracts and instruments which currently reference existing Benchmarks such as IBORs will need to be amended to reflect a new replacement rate or include more robust contractual fallbacks to specifically cater for any change in, disruption to, or cessation of, existing Benchmarks or for the possibility that existing Benchmarks may be deemed to be unrepresentative.
Please note that the application (or not) of new fallbacks or a replacement rate may cause a change in value of existing transactions and you are encouraged to obtain independent advice on your position.
The discontinuation of certain Benchmarks may result in a mismatch between the rate referenced in one financial instrument and other financial instruments, including potentially those that are intended to be linked such as certain derivative transactions which are entered into for hedging purposes. There is no assurance that the same trigger events and fallback methodologies will be incorporated into all financial contracts. Accordingly, basis risks may arise in transactions using derivatives and the related financial instruments which they are intended to hedge as these may adopt different triggers and fallbacks. The potential mismatches may impact the relative financial performance, financial reporting and value of existing financial contracts (including derivatives).
If a contract is amended to allow for the selection of an alternative Benchmark following the permanent cessation, disruption to or change of an existing Benchmark or when a Benchmark has been deemed to be unrepresentative, the method of calculation and rate of interest payable on such transactions may change. The alternative Benchmark may not be similar to, or behave in the same manner, as the original Benchmark and there is no guarantee that the rate of interest calculated on any such alternative Benchmark will be the same as the rate of interest that would have applied for any interest period if the original Benchmark had continued to be used. It is possible that the alternative Benchmark may result in a change to the amounts that would otherwise have been payable under the terms of a transaction as well as its value. Further, an amended Benchmark that is selected as a replacement (whether by amendment or through a fallback) may have a different methodology and economic consequences compared to: (i) an alternative Benchmark resulting from any legislative process or the exercise of any legislative powers and (ii) other alternative Benchmarks adopted widely in the market, including RFRs.
In light of the on-going Benchmark reforms, if you have entered into or have purchased (or may in the future enter into or purchase) any financial contracts (including without limitation, derivatives, loans and bonds) that reference a Benchmark (either directly or indirectly), you should be aware of possible changes in, disruption to, or cessation of, such Benchmarks and understand the potential market, liquidity, legal, operational, regulatory and financial impact and other risks on those financial contracts that reference such Benchmarks including the potential that such Benchmark may be altered, deemed unrepresentative or discontinued prior to the maturity of such financial contract.
This is an evolving area and you should monitor regulatory and market developments.
Further information on interest rate reform and IBOR transition can be found on the websites of the Financial Conduct Authority (FCA), the Bank of England, the U.S. Commodity Futures and Trading Commission (CFTC), the Federal Reserve Bank of New York (FRBNY), the U.S. Alternative Reference Rates Committee (ARRC), the European Central Bank (ECB), the Financial Stability Board (FSB), the International Organization of Securities Commissions (IOSCO) and some of the working groups and industry bodies that are also considering these issues including the International Swaps and Derivatives Association (ISDA), the Loan Market Association (LMA) and the International Capital Markets Association (ICMA).
Please consult your own independent advisers and make your own assessment about the potential impact before you enter into any financial contracts with, purchase any financial instruments from, or purchase any financial instruments issued by, SCB including transactions which amend concluded transactions with SCB.
Further risks relating to certain products are attached below:
- Risks Related to the Use of Benchmarks in Derivatives
- Risks Related to the Use of Benchmarks in Loans
- Risks Related to the Use of Benchmarks in Debt Securities
SCB makes no representation, warranty or recommendation, express or implied, as to the risks and/or consequences relating to a change in methodology or discontinuation of a Benchmark rate, or the appropriateness, suitability or expected economic value of any replacement, fallback or contingency option. In particular, SCB makes no representation that any replacement rate, fallback or contingency option will have the same methodology or economic consequences as an existing IBOR, a replacement rate derived from a legislative process or power or any other replacement rate widely adopted in the market.
SCB is not acting as a fiduciary or advisor to you, including in respect of any of the information set out in this document. None of the information set out in this document should be taken as constituting financial or investment advice or an invitation or inducement to enter into, amend, or alter, any financial contracts or investment activities. To the fullest extent permitted by applicable law, SCB accepts no responsibility or liability for any damage, expense or other loss you may suffer arising out of or in connection with any benchmarks (including in respect of any change or discontinuation of any benchmarks) or alternative reference rates and any information or statements provided in relation to them or any reliance you may place on such information or statements.
SCB makes no representation that any replacement rate that is selected by the parties in place of an IBOR in an existing transaction will be appropriate for related transactions to which you are also a party with SCB. In particular, no representation is given that a replacement rate in a derivative transaction will be economically linked or effective in respect of any other transaction.