By Takashi Umekawa and Alun John
TOKYO/HONG KONG (Reuters) - A tug-of-war between Japan's banks and companies has erupted over replacing the widely used but tarnished Libor benchmark, illustrating the difficulty for lenders, borrowers and regulators in adopting a replacement for the $400 trillion benchmark.
Libor, the London Interbank Offered Rate, underpinned the global market for loans, bonds and derivatives for decades. It is used to price everything from mortgages and credit cards to hedging contracts, protecting banks and companies from sharp price swings.
But in the aftermath of the financial crisis, regulators demanded change after banks were found to have manipulated the rates, resulting in some $9 billion worth of fines to date.
The crucial deadline is December 31, 2021, after which the U.K.'s Financial Conduct Authority, which regulates Libor, will not make banks submit the estimates from which it is calculated, meaning it will cease to exist.
Instead different markets have developed alternative rates, based on real transactions rather than bankers' estimates, to replace the different types of Libor. Current versions include the U.S. dollar, British pound, euro, yen and Swiss Franc.
The U.K.'s Financial Conduct Authority told banks they should be using their new rate, Sonia, for all new loans by Sept. 30, though they have since said this could be affected by the coronavirus outbreak.
Japanese banks and business, however, have been left with two competing rates and regulators have so far refused to favour either, leaving it to a cross-industry committee of banks, brokers and companies. The committee says the decision is down to individual companies.
The end-2021 deadline is nearer than it may sound given the numbers involved and the work to be done. About 6,500 trillion yen (48.47 trillion pounds) worth of Libor-related contracts exist in Japan, according to a joint survey by the Financial Services Agency and the Bank of Japan last month.
Shifting from Libor is one of the biggest challenges for the financial services industry globally, with costs estimated to run into billions of dollars.
Banks must put in place new software and systems to calculate and make loans using the new benchmarks, while current loans which reference Libor and continue into 2022 must be changed to reflect an alternative.
The longer it takes Japan to decide on which rate, the more difficult and potentially chaotic the changeover will be.
"If Libor-related financial contracts carry over end-2021 without deciding on a replacement, that would cause technical default," said Yuki Kanemoto, a director of Daiwa Institute of Research.
"Even though borrowers have enough money, they will not be able to pay interest because there's no interest rate benchmark. Lenders could face major losses.”
TIBOR V TONAR
Japan is witnessing a clear split between lenders and borrowers. Some 57% of Japanese banks say Tibor ought to be used as the alternative rate for loans.
Tibor, like Libor, is based on bankers' estimates of market interest rates, submitted daily but overseen by the Japanese Bankers Association, not UK regulators.
But 70% of companies prefer forward-looking term rate based on the Tokyo Overnight Average Rate, or Tonar, according to a November survey by the cross-industry committee. Banks including Citigroup (NYSE:C) and UBS were found by Japanese regulators in 2011 to have tried to manipulate Tibor, but regulators have since focused on strengthening the rate-setting process.
"The easiest way is to adopt Tibor as replacement because it already exists and we don't need to invest to update our system," said a source engaged in the transition at a major Japanese bank. Tonar, which is similar to new benchmarks being adopted in Britain and the United States, is based on short-term transactions.
While it has the benefit of being based on actual deals not estimates, some complex calculations are needed to build a series of longer-term reference rates from that for, say three-, six- and 12-month borrowing costs.
"Having an existing - but revised - benchmark alongside the new one gives banks flexibility if there are problems moving to Tonar, but it also means that there are doubts in places about which to use, particularly for the backbook (of existing contracts),” said Aude Schonbachler, a partner at Oliver Wyman.
Nikkei-owned vendor Quick Corp is expected to calculate and publish longer-term rates by mid-2021. "Some of us are still doubtful about the term rate. It should exist by now if there was need in the market," the banker said.
LIBOR REIGNS - FOR NOW With no consensus, many companies still insist on using Libor for new contracts. SoftBank Group Corp (T:9984) used Libor in an up-to-500 billion yen loan the company announced in February, two sources said. A spokeswoman for SoftBank said it didn't disclose details of the contract.
Amit Singh, Group Treasurer of Takeda Pharmaceutical (T:4502), one of Japan's most indebted companies, said work on identifying the scale of their Libor-related exposure started last year but, so far, they had not begun serious discussions about which replacement to use. "Once the recommendation comes from the cross-industry committee, we will work with our banks to implement it," he said.
The committee did not immediately respond to a request to clarify its plans.
Another reason for the delay is the lack of financial instruments using Tonar. Venetia Woo, global lead LIBOR advisor at Accenture (NYSE:ACN) said banks had been updating their systems, but were still waiting for enough underlying liquidity in Tonar hedging and funding instruments to update all of their loans.
The Japanese Bankers Association has produced a template with so-called fallback language for contracts that carry over the end of 2021 to help with a smooth shift, but this does not specify which rate should be used. "It's true that there are many uncertainties," said Makoto Takashima, ex-chairman of the association and the head of Sumitomo Mitsui Banking Corporation (SMBC). "We may run out of time if we wait for such challenges being solved. Banks need to start a dialogue with clients as early as possible."