27 June, 2019
The London Interbank Offered Rate (LIBOR) is a benchmark interest rate used by the international interbank loan market. It is used as a benchmark in a wide range of financial products such as syndicated loans, interest rate swaps, and forward rate agreements. In recent years, due to alleged calculation and manipulation scandals, confidence in the reliability and robustness of LIBOR has dwindled, despite a string of reforms. The UK’s Financial Conduct Authority has indicated that LIBOR may discontinue after 2021.
On 5 March 2019, the Hong Kong Monetary Authority (HKMA) issued a circular to request authorised institutions to make preparation for the transition from LIBOR to alternative reference rates. Currently, the HKMA has no explicit intention to discontinue the Hong Kong Interbank Offered Rate (HIBOR).
The LIBOR reform will impact financial institutions’ management and operations. In the context of investment funds, some asset allocation or fixed income hedge funds’ underlying portfolios may hold assets such as floating rate notes that bear interest rates based on LIBOR; LIBOR may be used as a reference for the fund’s investment objectives (for instance, the target return of the fund is to achieve LIBOR plus a percentage spread); investment managers may use LIBOR in calculations and models for operations and administration. By eliminating LIBOR, uncertainties may arise in pricing and liquidity of the underlying assets and also in interest rate calculation methodologies in the markets.
To prepare for the transition to alternative reference rates, asset managers should be aware that in addition to the operational changes, updates may also be required to fund documentation which directly or indirectly refer to LIBOR.
For instance, fund documents may need to be amended to address an alternative approach in the event that LIBOR is unavailable. Some fund documents require shareholder consent for changes to be implemented; others allow changes to be made by notice. In the latter case, if a change is material, such as affecting fee or the way in which the investment fund is managed, investors should be given an opportunity to redeem their investments before the changes take effect.
For further information, please contact:
Shanshan Liu, Deacons
shanshan.liu@deacons.com.hk
