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 benchmarks.
General Risks Related to the use of Benchmarks
Financial indices and reference rates (Benchmarks), such as Interbank Offered Rates (IBORs), in particular, the London Interbank Offer Rate (LIBOR), are 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) have published principles and statements in relation to Benchmarks since 2013.
- The Financial Stability Board (FSB) and other regulators 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) in European Union, that govern the administration, contribution to and use of Benchmarks.
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.
- 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 change to, or cessation of, relevant Benchmarks.
Traditional contractual fallback solutions to the unavailability of an existing Benchmark (“fallbacks”) 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 or may not produce any results and it is 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. 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, if there is a need to reference existing Benchmarks, there may be merit in updating the terms of some financial contracts to 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 may cause a change in value of existing transactions.
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 as hedges. 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 or other related financial instruments that adopt different triggers and fallbacks. The potential mismatches may impact the hedge effectiveness, financial reporting and value of existing financial contracts.
Even if a contract has been 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. There is no guarantee that the alternative Benchmark will be similar to, or behave in the same manner, as the original Benchmark or 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.
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. 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.
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 or suitability of any of fallback or contingency option. 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.