(April 2): ​​Japan is emerging as a major concern in the global migration away from the London interbank offered rate.

Barely nine months before the yen Libor was abolished, only a fraction of the roughly 3 quadrillion yen (US $ 27 trillion) of derivatives indexed to the discredited benchmark index switched to alternative benchmarks. An additional $ 150 billion in spot products such as loans and floating rate notes – many of which cannot be easily transferred to new benchmarks – are not expected to mature until after the Libor expires, according to Fitch Ratings.

As the deadline approaches, concerns are growing that the country could face a messy transition at the end of the year, marked by technical issues, legal disputes and increased volatility in interbank rates. Global regulators overseeing the end of Libor announced in March that they were considering creating a “ synthetic ” yen rate as an interim measure to allow more so-called hard legacy contracts to come off the books.

“The problem is across the spectrum,” said Willie Tanoto, director of financial institutions at Fitch Ratings in Singapore. “Things can still fall into place over time, it’s just that there is very little room for error.”

The Bank of Japan and the Financial Services Agency say they will monitor the progress of companies and take necessary action. Companies should work to stop issuing new loans and bonds that refer to yen Libor by the end of June, and significantly reduce the amount of such securities on their books by the end of September, according to a statement. spouse. A representative of the BOJ-backed cross-sector committee on Japanese yen benchmark interest rates declined to comment.

Japan, like the United States, United Kingdom and others, has raced against time to prepare for the demise of Libor, a staple of the financial system being phased out by global policymakers due to ‘a lack of underlying trading and as a result of a profile rigging scandal. Japan’s total exposure is limited from the US $ 223 trillion pinned to its dollar equivalent, where progress has also been slow.

Yet while Britain’s main Libor replacement has been around since 1997 and its US counterpart launched three years ago, markets are still waiting for one of the main alternatives to Yen Libor to be launched in April, less than nine months before the expiration of the old benchmark.

While the United States at the end of last year extended the withdrawal date for key dollar tenors Libor by 18 months, such a move has proved impractical in Japan due to lack of support from panel banks. that help determine the rate. Decisions taken by Japanese authorities in recent years have also added an additional layer of complexity to parts of the transition.

Unlike the United States and the United Kingdom, the Japanese authorities are not pushing market players towards a single alternative to Libor. The move to reform and keep alive Tokyo’s Libor-like Interbank Offered Rate, or Tibor, could slow adoption of the new Tokyo Average Overnight Rate, or TONA, according to Fitch. The TONA will be used primarily for derivatives while another benchmark, the Tokyo Risk-Free Term Rate, or TORF, will be used for loans and bonds.

In fact, only 3.5% of the yen risk in OTC and exchange-traded interest rate derivative transactions was indexed to TONA in February, according to data and analysis firm Clarus Financial. Technology, among the lowest alternative rates. monitors.

“The TONA market is not ready to absorb the global exposure to Libor,” said Takeshi Iwaki, director at Deloitte Japan, but added that many remain optimistic about the recovery in volumes in the coming months.

Lack of liquidity could also delay efforts to develop a forward-looking TONA-based term structure that allows borrowers to know their interest payments in advance, seen as key to facilitating wider adoption, according to Fitch.

Legacy issue

Equally worrying to some are Japan’s struggles to resolve difficult legacy contracts that will still be tied to Libor when it expires.

Unlike the United States – where lawmakers are pursuing legislation that would impose cutback rates on problematic deals – Japanese officials have made little progress in addressing the problem, according to market watchers.

Senior officials at Japan’s FSA, which is also involved in transition planning, say the scope of the legacy issues is limited. And the move to new rates could also make further progress once the TORF is launched, these officials say.

TORF remains at the prototype stage, and financial information company QUICK Corp. is expected to start posting the rate on April 26. The BOJ expects Yen Libor contracts to start seriously shifting to alternative rates once TORF begins in April, and sees most transitions completed by the end of September.

For its part, the UK regulator that oversees Libor said in March it plans to consult on setting up a synthetic yen Libor for an additional year to allow more legacy contracts to mature.

While the rate cannot be used for new trades, it could help prevent a wave of lawsuits between counterparties to Libor trades once the benchmark ceases to be published.

But synthetic Libor is not a panacea and bankers will still have to work on adjusting existing contracts, according to Fitch’s Tanoto.

Others see more reason to be optimistic. A draft version of TONA could be released as early as mid-year, according to Ann Battle, head of benchmark reform at the International Swaps and Derivatives Association.

“We would expect to see a steady increase in TONA’s liquidity over this year, especially now that the timing of Libor’s demise is clearer,” she said via email.

Yet if there are plans in place to facilitate a smooth transition, they must do so quickly. Earlier this year, Clarus warned the administrator of Libor that the country’s derivatives market is in a “precarious position” given the low adoption of alternative benchmarks.

“I know how difficult it is to create a new market, I know how difficult it is to move cash from one product to another,” said Chris Barnes, senior vice president of Clarus. “It still seems to be a big concern.”