Insight & Analysis

Singapore trade finance transaction a reminder of IBOR uncertainty

Published: Oct 2021

The Secured Overnight Financing Rate might be leading the field, but as the deadline for ceasing new deals tied to LIBOR looms, other risk-free rates are battling to gain traction.

Retro clock

In early October, DBS completed what it described as Singapore’s first trade finance transaction referencing the Bloomberg Short-Term Bank Yield Index (BSBY).

The bank referred to BSBY as an important option for high volume supply chain transactions requiring straight through processing, although it also stressed that it would continue to support and offer Secured Overnight Financing Rate (SOFR) based pricing.

Alternative rates such as the ICE Bank Yield Index, Ameribor and BSBY were initially designed to support US cash markets. UK regulators have made it clear that they are not encouraging UK banks to materially use some of these credit sensitive indices, as their underlying transactions may be insufficient to support an index used on a larger scale and in stressed conditions.

According to James Lewis, UK LIBOR lead at KPMG, it is hard to quantify the number of corporates that have used these rates within cash products.

“Corporate treasurers may be interested given they look a little more similar to LIBOR,” he says. “However, I think this is more to do with the fact they have a term structure (rates for O/N, 1m, 3m, 6M, 12M, and so on). I am not sure treasurers are concerned about backing a general bank credit element into the index they use.”

Chris Long, Principal, Financial Services Advisory at KPMG US, observes that SOFR has had a significant advantage in the marketplace since it was launched earlier and has a certain degree of backing from regulators and the Alternative Reference Rates Committee.

“With the recent approval of Term SOFR rates, one more obstacle (complexity in calculating the rate and choosing between ‘in advance’ or ‘in arrears’ rates) for borrowers has been removed,” he says. “Corporate treasurers have also shown less interest in credit sensitive rates – which may increase under stress – than have lenders, who see those rates as a mitigant to cost of funds increasing at the same time as lines of credit are drawn.”

Speaking at an AFME/IMN event in mid-September, Toby Williams – a technical specialist in the FCA’s benchmarks policy team said UK and US regulators have been clear in their views on the use of credit sensitive rates as potential replacements for US dollar LIBOR and noted that IOSCO had put out a statement that should leave no doubt on the risks inherent in the use of such rates.

Long refers to a ‘handful’ of BSBY and Ameribor transactions with clients, as well as bank debt issuance and some swaps. “SOFR currently dominates, but the situation bears watching over the next few months,” he adds.

When asked whether BSBY, the ICE Bank Yield Index or Ameribor are particularly suitable for high volume supply chain transactions, Lewis notes that most would only be suitable for USD-based transactions at this stage.

“The fact they have a forward looking element is likely to help certain use cases such as factoring,” he says. “However, it still worth considering the guidance around usage of Term SOFR or Term SONIA.”

The Alternative Reference Rates Committee’s public support for the use of the SOFR Term rate for trade finance lending should ease the transition from LIBOR and reduce the operational complexities of dealing with an overnight rate whilst still providing the ability and flexibility to hedge exposures.

“The alternative rates could be suitable for use in trade finance, along with business lending,” says Long. “However, there has recently been significant regulatory focus on the suitability of these rates that could impact broader market adoption and concentrate liquidity in SOFR.”

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