J u n e 8 , 2 0 2 1
Bank of Japan
LIBOR Transition in the Final Stage:
No Deus ex Machina
There will be
Speech at the NIKKEI Financial Online Seminar
Held by Nikkei
AMAMIYA Masayoshi
Deputy Governor of the Bank of Japan
Introduction
It is my pleasure to have the opportunity to speak to you today about the LIBOR
transition at the NIKKEI Financial Online Seminar.
The LIBOR transition refers to the replacement of LIBOR with alternative interest
rate benchmarks in financial products referencing LIBOR. It is a significant issue that
we have been facing not only in Japanese financial markets but also in global financial
markets, to ensure smooth transactions going forward.
This year, a landmark event took place on March 5 with regard to the LIBOR transition.
On that day, the future cessation and loss of representativeness of all the LIBOR
currency tenor settings were formally determined.1 Accordingly, the publication of
LIBOR will be ceased for most of the currency tenor settings, including those of
Japanese yen, at the end of this year. On the other hand, major U.S. dollar LIBOR
tenor settings that are most widely used will be ceased at the end of June 2023.
Many market participants had already been aware of the possibility of the cessation
of LIBOR long before this event; nevertheless, it was still significant that these official
announcements on the future cessation of LIBOR were actually made. In other words,
it was fully clarified that yen LIBOR, which had been used so widely, would no longer
be available at the end of this year for sure. Now that the deadline for the transition is
unarguably fixed, we only have less than seven months until the permanent cessation
of yen LIBOR.
If we compare a series of events related to the LIBOR transition to a play, then we can
say that the final act of the play,
which originated in the manipulation scandal that
has started with these official announcements of the cessation
came to light in 2012,
of LIBOR publication. At this moment, however, there are still many transactions in
Japan that are not prepared for the transition away from LIBOR to alternative interest
rate benchmarks. We still have many difficult issues to solve in this final stage,
although the time we have left is very limited. Speaking of "the final act of the play"
that I just mentioned, in ancient Greek theater, a plot device called deus ex machina
was sometimes employed, where the absolute god revealed itself and solved all the
difficult issues in the hardships. The term was coined after the Latin word machina
("machine") as the actors playing the god were brought onto stage using a crane-like
machine. In the final stage of the yen LIBOR transition, however, there will be no
deus ex machina by any means.
Most of the necessary tools to achieve a smooth LIBOR transition have been already
provided, thanks to the deliberation and efforts made by relevant groups and bodies
at home and abroad to facilitate each transition activity. Within the remaining time,
the success of the LIBOR transition essentially depends on whether each individual
market participant will make a good use of those tools and take necessary actions in a
steady and swift manner. We are no longer in a phase to consider the feasibility of the
LIBOR transition; we are already in the phase to be fully determined to make steady
progress in the transition activities for the completion of the LIBOR transition.
Today I would like to briefly look back on the events leading up to the current situation.
Then I would like to focus on the yen LIBOR transition and present points that each
individual market participant should take note of in implementing their own transition
activities.
I. LIBOR Transition
A. Background
First of all, let me start by briefly reflecting on the course of events concerning the
LIBOR transition and corresponding initiatives in Japan.
We can divide the past events related to the LIBOR transition into three different
stages in retrospect. The first stage started in 2012, when it came to light that there
had been a market manipulation and false reporting of LIBOR. As a result, the interest
rate benchmark reform soon gained momentum internationally, but the focus of the
reform at that time was still on how to improve the robustness of LIBOR as an interest
rate benchmark, on the premise that LIBOR publication would be continued.
Subsequently, in July 2017, the second stage began with a speech given by then Chief
Executive Andrew Bailey of the U.K. Financial Conduct Authority (FCA). In his
speech, he strongly suggested for the first time the possibility of the permanent
cessation of LIBOR at the end of 2021. The speech shifted the nature of the interest
rate benchmark reform dramatically, from the pursuit of LIBOR enhancement based
on the assumption that its publication would be continued to initiatives for the
transition to new interest rate benchmarks on the assumption that LIBOR would be
permanently ceased. Then, as I mentioned in the beginning, the third and final stage
of the LIBOR transition started in March 2021 against a background of the formal
announcement with regard to the permanent cessation of LIBOR for all currencies in
the future.
Let me turn to the initiatives taken in Japan corresponding to each of these three stages
(Chart 1). In the first stage, where the continuation of LIBOR publication remained
intact, various efforts were made to enhance the robustness of the Tokyo InterBank
Offered Rate (TIBOR), a financial benchmark based on interbank rates in the Tokyo
market, within the framework of the interest rate benchmark reform in conjunction
with yen LIBOR. In July 2017, such efforts came to fruition and important
improvements were made, including increased transparency of the calculation and
determination processes of submission rates for TIBOR. Moreover, the identification
of a Japanese yen risk-free rate based on the rates of actual overnight transactions as
a new interest rate benchmark was also considered. Consequently, in December 2016,
the uncollateralized overnight call rate calculated and published by the Bank of Japan
was identified as the yen risk-free rate in Japan.
Thereafter, in the second stage, where the preparations for the possible permanent
cessation of LIBOR became a critical issue, the Cross-Industry Committee on
Japanese Yen Interest Rate Benchmarks (hereafter the "Committee") was established
in August 2018. The Committee, of which the Bank of Japan serves as its secretariat,
consists of a wide range of market participants from various businesses, including
financial institutions and non-financial corporates. It conducted necessary
deliberations from various viewpoints to help benchmark users to appropriately
choose and use Japanese yen interest rate benchmarks as alternatives to yen LIBOR.
In the current third and final stage, which determines the success of the yen LIBOR
transition, the focus has shifted to the actual implementation of the yen LIBOR
transition activity by each individual market participant, as necessary tools to facilitate
each transition activity are already set ready for use in general, reflecting further
progress made in deliberations by relevant bodies, including the Committee.
B. Alternative interest rate benchmarks to LIBOR
Now, let me briefly explain what options are available for alternative benchmarks to
yen LIBOR (Chart 2).
There are three options available in Japan. One of the options is TIBOR, which I
mentioned earlier. TIBOR is the
calculated and published by Japanese Bankers
TIBOR Administration based on interbank rates submitted by 15
Association (JBA)
financial institutions in Japan, including major banks.
Another option we have is overnight (O/N) risk-free reference rate (RFR)
Compounding (Fixing in Arrears) (hereafter "compounding in arrears"), which uses
the uncollateralized overnight call rate in Japan.2 I will go into a little more in detail,
because the term may not sound familiar to everyone. For example, the 3-month
floating rate referencing the compounding in arrears is essentially derived from
cumulative interest calculated by rolling over the borrowing with the uncollateralized
overnight call rate for every day of the preceding 3 months before the next payment
date. The compounding in arrears should be the most robust interest rate benchmark
as it is calculated using the uncollateralized overnight call rate reflecting actual
transactions. The amount of the next payment based on the compounding in arrears
only becomes known just before the timing of the actual payment. Hence it may be
less compatible with operations and systems that are based on the condition
existing
that the amount of the next payment is well known in advance. The introduction of
the compounding in arrears could require relatively higher costs compared to other
options.
The last option is a term risk-free rate, called TORF (Tokyo Term Risk Free Rate) in
Japan. TORF
is an interest rate benchmark based on the overnight index swaps (OIS)
a fixed interest rate exchanged in the interest rate swaps (IRS) to a floating rate
rate,
calculated using the compounding in arrears over each coupon period. Since the
amount of the payment with TORF is well known in advance, like the case of LIBOR,
TORF may be relatively more compatible with the existing operations and systems.
However, there are important issues with the use of TORF to be addressed in terms of
robustness as a financial benchmark, such as the establishment of the governance
structure, the improvement of transparency in the calculation process, and the
sufficiency of market liquidity of the underlying OIS market.
multiple alternative interest rate
As I have just laid out, there are options for
benchmarks market participants need to
to yen LIBOR. Under these circumstances,
consider the optimal selection of the benchmark options financial
according to the
products they have, transactions they face, their own individual
the nature of and
business needs, and then to begin new transactions or
make changes to their legacy
the chosen alternative benchmark.
contracts with
To support initiatives by each of market participants, the Committee has provided the
results of various discussions and deliberations and some recommendations
concerning the LIBOR transition. Among those provided by the Committee is
"Roadmap to Prepare for the Discontinuation of Japanese Yen LIBOR" (hereafter the
"Roadmap"), which indicates milestones that market participants should take into
account in the making of their own roadmap for transition.3
In the next section, I would like to explain three points that market participants should
note, mainly by addressing major milestones in the Roadmap.
II. Toward the acceleration of the LIBOR transition
A. Cessation of the issuance of new transactions referencing yen LIBOR
First, according to the Roadmap, the issuance of new transactions for loans and bonds
referencing yen LIBOR needs to be ceased by the end of this June (Chart 3). The
Roadmap is based on the consensus of major market players in a wide range of
businesses, which was reached through a series of their deliberations with related
international discussions taken into account. Given the existence of the consensus, it
is important that market participants complete their preparations for conducting new
transactions referencing alternative interest rate benchmarks within the remaining
time of less than one month.
Tools necessary for ceasing the issuance of new transactions by the end of this June
are already available. In July 2019, the Committee carried out its first public
consultation on the choice of alternative interest rate benchmarks to yen LIBOR,
including the ones for new loans and bonds, in order to solicit comments from a wide
range of market participants. The results of the first public consultation were then
published in November the same year. They showed that a term risk-free rate received
the most support as an alternative benchmark, although neither its calculating and
publishing entity nor its name was determined at that time.4 Following the results,
QUICK Corp. was selected later by the Committee as a calculating and publishing
entity of the term risk-free rate. Subsequently, the publication of prototype rate started,
with the name of the term risk-free rate, derived from OIS rates, decided to be TORF.
Then, strenuous efforts of the relevant bodies and authorities continued for the
establishment of the governance system and the improvement in the transparency of
the calculation process of TORF. Consequently, the publication of a production rate
for TORF designed for the use in actual transactions started on April 26 this year,
about two months ahead of its initial schedule.5
Accordingly, all the three alternative benchmarks
of necessary for new transactions
TIBOR, the compounding in arrears, and TORF market
-- -- are now available. Some
participants that
had commented it was difficult to start new transactions referencing
became
an alternative benchmark unless all the options for alternative benchmarks
for comparing the level of an interest rate
available, for example, based on each of the
such a point is no longer an impediment to the cessation of the issuance
options. Now,
of new transactions referencing yen LIBOR. I that market participants
strongly expect
will appropriately carry out new transactions for loans and bonds referencing
alternative interest rate benchmarks from this June onward.
the end of
B. Substantial reduction in legacy contracts referencing yen LIBOR
Second, according to the Roadmap, the amount outstanding of legacy contracts for
loans and bonds referencing yen LIBOR needs to be reduced substantially by the end
of this September (Chart 4).
To achieve this milestone, market participants are expected either to immediately
renew the terms of legacy contracts concerning the reference to yen LIBOR into new
terms of contracts referencing alternative benchmarks, or to incorporate an
appropriate fallback provision in the contracts. The incorporation of fallback
provisions in legacy contracts is an approach where contracting parties reach an
agreement in advance to make sure, with a robust fallback provision, that yen LIBOR
will be surely replaced with a replacement rate using an alternative benchmark, given
the permanent cessation of yen LIBOR. It is significant in the sense that a robust
fallback provision can ensure a future reduction in the amount outstanding of legacy
contracts. Therefore, it is important for market participants to make progress in the
incorporation
of the robust fallback provision, in addition to transitioning to
alternative benchmarks, so that the yen LIBOR transition for legacy contracts will be
fully taken care of before its permanent cessation.
Tools necessary for the incorporation of the fallback provision are also available now.
In August 2020, the Committee carried out its second public consultation on the
recommended fallback provision with its waterfall structure in legacy loans and bonds.
The results of the second public consultation were published in November the same
year, which showed that many market participants supported the recommendation by
the Committee to give TORF the first priority and the compounding in arrears the
second priority as fallback rates in the waterfall structure for both legacy loans and
bonds.6
All the options of alternative benchmarks in the fallback provision are also available,
as I mentioned earlier. With regard to bilateral loans and syndicated loans, samples of
the fallback provision are made available on the websites of the JBA and Japan
Syndication and Loan-trading Association (JSLA). I would like to ask market
participants yet again to proceed steadily with the incorporation of the fallback
provision by the end of this September with the use of these tools. Without the
backstop of the fallback provision, market participants are highly likely to face a
chaotic situation in the execution of legacy contracts referencing yen LIBOR whose
maturity date arrives after the end of this year.
In this connection, let me stress a point here: investors need to take more active roles
in the LIBOR transition concerning the incorporation of the fallback provision to
legacy contracts. In order to incorporate the new fallback provision, issuers of bonds
referencing yen LIBOR need to either hold a bondholders' meeting and change the
terms of its contracts by a majority vote, or to obtain the consent for such changes
from all the bondholders without holding a bondholders' meeting. In particular, for the
latter case requiring consents of all the bondholders, active participation of those
bondholders in the discussions and negotiations is essential for the success of the
amendment. In the LIBOR transition for bonds referencing yen LIBOR, the roles and
responsibilities of issuers are always visible; however, bondholders also bear
important roles. In the limited time left before the permanent cessation of yen LIBOR,
it is extremely important for both issuers and bondholders to recognize their own roles
in the transition activities concerning legacy contracts, including the incorporation of
the fallback provision.
C. Transition from yen LIBOR swaps to OIS
The last point that I will touch upon in my speech today concerns derivatives, not
loans and bonds. Specifically, let me talk about the need to cease new transactions of
yen LIBOR swaps and thereby to transition to those of OIS (Chart 5).
The Committee published a statement entitled "Preparations for the discontinuation
of LIBOR in the JPY interest rate swaps market" in late March this year.7 It requested
that market participants should cease the initiation of new transactions of yen LIBOR
swaps by no later than the end of this September, and they should do so as early as
possible, if practicable. It also clarified that OIS should be the dominant option which
would replace yen LIBOR swaps.
The statement by the Committee is well in line with the global standard concerning
the LIBOR transition in derivatives, as proposed by the Financial Stability Board
(FSB). It is therefore important for market participants in the yen interest rate swap
markets to make transition to OIS as early as possible, in accordance with the
statement. That will also lead to an enhancement of the liquidity of OIS, thereby
resulting in more robustness of TORF referenced in loans and bonds.
Conclusion
In my speech today, focusing on several milestones that I would like market
participants to note, I have talked about my expectations for them to utilize various
tools that the Committee and industry groups have prepared and thereby to swiftly
proceed with the LIBOR transition going forward.
There is no doubt that the LIBOR transition is very challenging. That is because many
market participants have to pay great costs in their transition activities, in terms of
changes in the current operations and revision of related systems. Accordingly, the
judgment will be made in a more careful and cautious manner, given the virtual
irreversibility of the decision due to those costs. As a result, in the LIBOR transition,
market participants tend to have more incentives to postpone their decisions by taking
more time to see how others will be proceeding and how market standards will be
developing along the way.
However, if many market participants collectively postpone their decisions on the
LIBOR transition, it would not only be socially undesirable but also undermine their
own benefits. Out of all the contracts referencing yen LIBOR among the surveyed
financial institutions, the amount outstanding of those maturing after the end of 2021
8
amounted to a total of 2,000 trillion yen as of the end of 2020. The continued
postponement of decisions in the yen LIBOR transition is highly likely to make an
orderly transition of this massive amount of LIBOR-related contracts very difficult to
achieve, which might in turn result in significant impacts on our financial system and
financial markets, thus hindering the sound economic activity of individual entities in
its extreme cases. To avoid those risks, the Committee and industry groups have been
making efforts to provide various tools to facilitate individual transition activities,
including the provision of recommendations, samples, and milestones.
There is only limited time left before the cessation of yen LIBOR at the end of this
year. The success of the orderly transition away from yen LIBOR relies on whether
each of market participants will proceed with their own LIBOR transition plan in a
steady and swift manner, with the use of tools available to them. Let me stress again
that deus ex machina will not appear in this final act of the play.
As the secretariat for the Committee and the central bank, the Bank of Japan will
continue to firmly support the initiatives by market participants in the remaining time,
while coordinating with the Financial Services Agency (JFSA) and paying attention
to overseas developments on the LIBOR transition.
Thank you very much for your attention.
LIBOR Transition in the Final Stage:
There will be No Deus ex Machina
Speech at the NIKKEI Financial Online Seminar
Held by Nikkei
June 8, 2021
AMAMIYA Masayoshi
Chart 1 Initiatives for the LIBOR transition in Japan
1st stage (2012-)

Both yen LIBOR and TIBOR (calculated based on interbank rates in the Tokyo market)
became subject to the enhancement of robustness as benchmarks

The uncollateralized overnight call rate was identified as the yen risk-free rate in Japan
2nd stage (July 2017-)

The Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks (the
Committee) was established. It promoted considerations on the choice and usage of
alternative interest rate benchmarks replacing yen LIBOR
Final stage (March 2021-)

With more progress made in the considerations, tools necessary for the transition are ready
-> Now the focus is on the actual transition activities by individual market participants
Chart 2
Three options for alternative interest rate benchmarks
TIBOR

Based on interbank rates submitted by 15 financial institutions in Japan, including major
banks
O/N RFR Compounding (Fixing in Arrears)

Based on the uncollateralized overnight call rate used in actual transactions

The most robust benchmark, but it may be less compatible with the existing administrations
and systems because the interest amount is only finalized just before the next payment
TORF(Tokyo Term Risk Free Rate)

The term risk-free rate in Japan

Based on the OIS rate, a fixed interest rate exchanged in the interest rate swaps (IRS) to a
floating rate calculated using the uncollateralized overnight call rate compounded in arrears

It may be more compatible with the existing operations and systems but how to establish its
robustness is a critical issue

The issuance of new transactions for loans and bonds referencing yen LIBOR needs to be
ceased by the end of June 2021
Tools for the success

The Committee indicated in the results of its first public consultation that the term risk-
free rate received the most support as an alternative benchmark

The publication of a production rate for TORF started on April 26, 2021 (about two
months ahead of its initial schedule)

The amount outstanding of legacy contracts for loans and bonds referencing yen LIBOR
needs to be reduced substantially by the end of September 2021
Tools for the success

The Committee indicated in the results of its second public consultation that its
recommendation to give TORF the first priority and the O/N RFR Compounding
(Fixing in Arrears) the second priority as fallback rates was supported by many market
participants

Industry groups, including the JBA, published samples for fallbacks in loans

New transactions of yen LIBOR swaps needs to be ceased and transitioned to those of
OIS
Tools for the success

The Committee published "Preparations for the discontinuation of LIBOR in the JPY
interest rate swaps market"

New transactions of yen LIBOR swaps should be ceased by no later than the end of
September 2021

OIS should be the dominant option replacing yen LIBOR swaps