The SC-STS published its Recommendations for Transition of Legacy SOR Contracts on 29 July 2021, with updated timelines and key recommendations for the industry-wide transition from SOR to SORA.
Market participants are urged to take active steps to substantially transition out of legacy SOR exposures by 31 December 2021, using the SOR-SORA basis swap market as a transparent and market-determined reference for the transition from SOR to SORA. Banks should actively transition their SOR corporate loans and derivatives exposures, taking into account customers’ interests when engaging them on a suitable transition approach. As the majority of corporate loans are written by the D-SIBs, the SC-STS and MAS will be closely tracking the D-SIBs’ wind-down of legacy SOR loans exposures so as to ensure a smooth transition.
Here is a summary of the key points:
Adjustment Spread Pricing and SOR-SORA basis swap / liquidity
- The use of SOR-SORA basis swap mid-rate pricing is a commercially reasonable starting reference for discussions between borrowers and lenders on converting legacy contracts from SOR to SORA. It should also minimise value transfer risk and avoid distortions to the market pricing. Whilst SOR remains available until 30 June 2023, the decline in SOR derivatives liquidity will accelerate in the coming quarters. The SOR-SORA basis swap market is expected to be liquid as the transition gathers pace, but is expected to become less liquid in 2022 as derivatives market approach the completion of transition from SOR to SORA.
- Banks should familiarise their customers with options that are available to them to convert legacy SOR loans, including the key considerations and risks associated with each approach.
- Relevant factors to consider include the loan maturity profile of their loans, options for conversion, ongoing hedging requirements and risks of undertaking another benchmark transition when Fallback Rate (SOR) is discontinued immediately after 31 December 2024.
- Banks and their customers should use the SOR-SORA basis swap mid-rate as the starting basis for discussing the adjustment spread for converting loans from SOR to SORA.
- To minimise impact on hedge effectiveness, Borrowers with hedged loans should convert both loan and swap to the same interest rate on the same date.
- For syndicated loans, Agent Banks should lead the coordination among lenders, borrowers and all other parties to the syndicated loan in order to facilitate a smooth loan conversion to SORA.
- Market participants should actively transition out of SOR derivatives by end-December 2021, in tandem with banks’ gradual wind-down of their SOR exposures in the months ahead.
- Financial institutions should use the SOR-SORA basis swap market along with compression and conversion cycles, to facilitate their exit from SOR derivatives and transition to SORA. With SOR liquidity expected to decline with market participants shifting their activities to SORA, market participants which have not planned for the transition of their SOR derivatives in the coming months should do so as soon as possible.
- The SC-STS envisages that the industry should successfully wind down most cleared SOR derivatives exposures in 2021, with the exit from cleared SOR derivatives to be fully completed well before SOR discontinuation in mid-2023.
- LCH (which clears an estimated 99% of cleared SOR derivatives) will undertake a Price Alignment Interest (PAI) / discounting rate switch from SOR to SORA in August 2021. Clearing houses are also expected subsequently to convert any remaining cleared SOR trades to SORA, before the discontinuation of SOR in mid-2023 or when SOR derivatives become illiquid. Financial institutions should reduce their gross and net risk exposures to centrally cleared SOR derivatives across the entire curve in order to minimize any unintended valuation effects when clearing houses convert SOR contracts to SORA.
- In terms of cross currency basis swaps, financial institutions should participate in vendor-provided compression cycles to reduce their exposures to USDSGD cross currency basis swaps
- By 31 December 2021, market participants should endeavour to amend their bilateral credit support annexes (CSAs) that use SOR as interest rate to SORA.
- Banks should inform and provide options to retail customers to voluntarily convert their legacy SOR loans as soon as possible and no later than 31 October 2022.
- The SC-STS recommends a simplified transition approach where banks would provide retail customers with a SORA Conversion Package at no additional fee or lock-in. Such SORA Conversion Package will be made available to retail customers with legacy SOR loans from 1 September 2021 to 31 October 2022 to facilitate their voluntary conversion to a comparable SORA loan.
- To provide flexibility and choice, Banks should also allow customers to reprice to any other loan packages that the bank may be offering to new customers but SIBOR loans should not be offered.