MNI INTERVIEW: Synthetic Yen LIBOR Must Be The Exception: BOJ Aide

Financial institutions should complete their transition away from LIBOR, as a year-end deadline to switch away from the interbank lending tool nears, a senior Bank of Japan official said.

"The most important thing is that financial institutions should not thoughtlessly rely on synthetic yen LIBOR and they are required to complete the transition from yen LIBOR by the end of this year," Akira Otani, the head of the BOJ's Financial Markets Department told MNI in an interview.

"They also must transit yen LIBOR contracts that introduced fallback provisions to new contracts steadily," he added.

Otani said, "The use of synthetic yen LIBOR will be limited to contracts that cannot feasibly be transitioned away from JPY LIBOR (so-called "tough legacy" contracts)."

In Japan, the volume of tough legacy contracts is very small as the balance of LIBOR-related contracts targeted retailers and smaller firms was considerably small, compared with those of the U.S. and the UK, he noted.

Japan has pledged to move to alternatives such as TORF (Tokyo Overnight Average Rate) or TONA (Tokyo Overnight Interbank Offered Rate). Another alternative is TIBOR – the Tokyo Interbank Offered Rate – which is calculated and published by the Japanese Bankers Association TIBOR Administration.

Otani pointed out that financial institutions are making progress with the transition from yen LIBOR.

At the end of September, 85.1% of LIBOR-related loan contracts have already incorporated fallback provisions and 51.6% of LIBOR-related bond contracts have already incorporated fallback provisions, the BOJ and the Financial Services Agency said in a joint survey of the progress of the switch released on Nov. 1. As for LIBOR-related derivatives contracts, 99.1% have already incorporated fallback provisions. .

Otani said, that only two months are left until the end of this year and it is important that market participants continue to proceed the transition away from yen LIBOR.

SAFETY NET

Market participants may use synthetic yen LIBOR as a "safety net" but it will be available only for one year and it will be calculated on a methodology different from the one used for panel-based JPY LIBOR.

The use of synthetic yen LIBOR should be limited to tough legacy contracts that cannot feasibly be transitioned away from yen LIBOR. As market participants are making steady progress in the transition, there are no contracts for which the use is expected at the moment, Otani said.

"Tough legacy contracts aren't specified now. But we cannot deny the possibility that there may be some contracts that cannot feasibly be transitioned away from LIBOR."

Therefore, the Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks has sought comments on possible tough legacy contracts in the public consultation that could consider using synthetic yen LIBOR. The committee gathered comments from a wide range of relevant parties on the basic concept on specifying tough legacy contracts for which the adoption of synthetic yen LIBOR may be considered and points to note when adopting the synthetic yen LIBOR. Based on the comments received in response to the public consultation, the committee plans to publish the results in November.

Otani warned that there is a risk of disputes arising to the contract if synthetic yen LIBOR is used without agreement between contracting parties because the economic value of a contract referencing panel-based LIBOR and synthetic yen LIBOR may change.

In order to mitigate litigation risks regarding the use of synthetic yen LIBOR, measures to share understanding among contracting parties may be considered, even if they do not reach an agreement, he added.

Otani cited the results of the public consultation to be regarded as a standard or "best practice" in Japanese markets and a wide range of market participants in Japan are expected to proceed with their preparations for the transition in line with the results. He also said, however, these results will not preclude contracting parties from reaching an agreement that differs from what is presented in the results.

He added that it is important that each financial institution proceeds to explain to its customers and amends contracts to progress either active conversion or insertion of fallback language as soon as practicable.