In March, we issued two circulars to all banks in Hong Kong. The first one reminded them to undertake risk assessment and make preparation for the necessary transition. The second one served to clarify that genuine amendments to existing derivatives contracts which are made to give effect to interest rate benchmark reform will not be considered new contracts from the perspective of the HKMA’s margin requirements. This removes one of the uncertainties about the transition. For the time being, we have not specified a timeline for the banks to get ready their transition plan but we will approach them at a later stage to understand their progress and readiness for the transition. HIBOR and HONIA 15. As financial institutions in Hong Kong are gathering pace in their preparation for the LIBOR transition, we are also making progress in identifying an alternative reference rate for HIBOR. We understand market participants are keen to have forward-looking term rates to mirror the structure of HIBOR. Therefore, the HKMA conducted a feasibility study of compiling HKD term rates based on actual wholesale funding transactions by major banks. But the results showed that while transaction-based wholesale term funding rates generally followed term HIBORs, they exhibited a high level of daily volatility, which made them an impractical substitute for term HIBORs. 16. More recently, TMA proposed adopting the Hong Kong Dollar Overnight Index Average (HONIA) as the alternative reference rate for HIBOR. Similar to many alternate reference rates chosen in other currency areas, HONIA is an overnight interbank funding rate.

With its growing international dimension, Islamic finance has assumed an increasingly important role in facilitating regional and international trade and investment flows thereby intermediating significant cross border financial flows. More recently, international financial centres such as London and Hong Kong have been increasing their connectivity with the Middle East and Asian regions, two important growth centres in the global economy. The increased international dimension of the sukuk market, in particular has facilitated the movement of funds across borders from jurisdictions with surplus funds to regions with investment opportunities thereby enhancing its potential as a vehicle to foster greater trade flows and investment and thus facilitating growth and development. The development of Islamic finance and its risk-sharing and equity financing aspects could be significantly rewarding for countries that venture into this alternative form of financial intermediation. However, to fully realise its potential, different elements of the financial system must evolve in tandem to provide the enabling conditions for this to occur. In such a system, it is essential for both investors and entrepreneurs to embrace different approaches in managing risk and return relationships that are embedded in the many variations of Shariah contracts. It is important that these relationships are well understood by the parties involved, and aligned with the clear contractual and operational requirements. 4  BIS central bankers’ speeches  Islamic finance: financial stability issues and challenges It is imperative that the lessons of the global financial crisis are not lost as the growth of Islamic finance gains further traction.