SGD SWAP OFFER RATE (SOR) DISCONTINUATION AND CONTRACTUAL FALLBACKS

Last updated: 01 September 2020

Background/Overview

  • SOR, which relies on USD LIBOR in its computation, is expected to cease after end-2021. This follows from the UK Financial Conduct Authority (FCA)’s statements that USD LIBOR would be discontinued or become non-representative after end-2021. Further, FCA has highlighted that market participants should be prepared that an announcement of LIBOR’s permanent cessation after end-2021 could come as early as November or December 2020.

  • SC-STS has identified the Singapore Overnight Rate Average (SORA) as the risk-free-rate to replace SOR, and it is in the interest of financial markets and participants to transition to SORA well ahead of end-2021. This would ensure that parties to transactions have good control over the timing and execution of their transition measures. As set out in the Transition Roadmap, SC-STS targets to publish market guidance on transition approaches in 4Q 2020.

  • At the same time, market participants should put in place robust contractual fallbacks to address the risk of contractual frustration or settlement issues when SOR is discontinued. This is to cater to the situation where market participants are unable to complete the transition of all their SOR contracts to SORA by end-2021. SC-STS has worked with the International Swaps and Derivatives Association (ISDA) to develop and implement robust contractual fallbacks for SOR derivatives. SC-STS is also finalising its recommendations for contractual fallbacks for cash products such as loans and floating rate notes. Further information on fallbacks for contracts that reference SOR can be found below.

Contractual Fallbacks for SOR Derivatives

  • SC-STS’ Derivatives Sub-group has worked closely with ISDA on the hierarchy of fallbacks for SOR derivatives (see Table 1). Existing contracts between any two parties that adhere to ISDA's IBOR Fallback Protocol, and all new derivatives transactions will incorporate this waterfall of fallbacks.

  • Specifically, Fallback Rate (SOR) has been identified as the primary fallback reference rate for SOR derivatives, and would be triggered upon the first to occur of (i) the permanent discontinuation of USD LIBOR, or (ii) the USD LIBOR being declared non-representative. This followed ISDA’s May 2019 consultation, which showed good support among market participants for the use of Fallback Rate (SOR), and SC-STS’ review on the relative merits of Fallback Rate (SOR) and fallback rates based on SORA. Notably, with Fallback Rate (SOR) more similar to and correlated with SOR relative to fallback rates based on SORA, the use of Fallback Rate (SOR) as the fallback reference rate would reduce the risk of value transfer and is expected to receive greater market support.

  • For SOR derivatives contracts that require a Fallback Rate (SOR) for a length of time not equal to the tenor of the reference benchmark (“stubs”) – e.g. where interest payment is required for a 2-month period while there are only 1-month and 3-month SOR benchmarks and Fallback Rate (SOR) benchmarks:

    • Where market participants had specified in their derivatives contracts the use of interpolation for computation of interest amounts for stubs, the interest payments will be computed by applying the relevant interpolated FX data (E.g. 2-month forward points interpolated from the 1-month and 3-month forward points) to a USD rate that follows the procedure for interest amounts in USD LIBOR derivatives contracts where interpolation has been specified.

    • Where market participants had not specified in their derivatives contracts the use of interpolation for computation of interest amounts for stubs, the interest payments will be computed by applying the relevant non-interpolated FX data to the latest available corresponding tenor of Fallback Rate (SOFR) (e.g. 3-month forward points could be used for settling stubs of a 2-month period).

    • Further details on these approaches for stubs may be found in the proposed IBOR Fallback Supplement.1,2

  • Other fallback reference rates will apply if Fallback Rate (SOR) is subsequently discontinued. The full hierarchy of fallbacks (see Table 1) is set out in ISDA’s IBOR Fallback Supplement.

  • SC-STS strongly encourages market participants to sign-up to ISDA’s IBOR Fallback Protocol. ISDA is expected to publish its IBOR Fallback Supplement and IBOR Fallback Protocol in 3Q 2020.

Table 1: Contractual Fallbacks for SOR Derivatives.

Derivatives’ Fallbacks
Main 
Fallback Rate (SOR)
Subsequent 1  MAS or appointed industry committee’s recommended rate 
Subsequent 2  SORA Compounded-in-Arrears 

1 Refer to Section 7.10 (Fallbacks for SGD-SOR-VWAP and THB-THBFIX-Reuters for Calculation Periods to which “Linear Interpolation” is specified to be applicable) of the proposed IBOR Fallback Supplement.


2 Refer to Section 7.11 (Fallbacks for SGD-SOR-VWAP and THB-THBFIX-Reuters for Calculation Periods to which “Linear Interpolation” is not specified to be applicable and which are shorter than the Designated Maturity) of the proposed IBOR Fallback Supplement.

Contractual Fallbacks for SOR Cash Products (Loans, Floating Rate Notes)

  • SC-STS’ cash market Sub-groups are also reviewing contractual fallbacks for their respective product areas. The preliminary proposal for business loans is to align to the hierarchy of fallbacks for SOR derivatives, with Fallback Rate (SOR) being the primary fallback reference rate. SOR floating rate notes, which is a relatively small market, will adopt SORA-based rates as their primary fallback reference rate.

Fallback Rate (SOR)

  • Similar to SOR, Fallback Rate (SOR) is an FX-implied rate. However, Fallback Rate (SOR) uses the fallback for USD LIBOR contracts (i.e. “Fallback Rate (SOFR)” published by Bloomberg, which is calculated by compounding USD Secured Overnight Financing Rate (SOFR) and adding the relevant spread adjustment instead of USD LIBOR in its computation. The methodology for computation of Fallback Rate (SOR) may be found here.

  • Market participants should make the necessary operational and systems preparations to cater to the use of Fallback Rate (SOR) for legacy SOR derivatives contracts. As compounded SOFR is used to compute Fallback Rate (SOR) and compounded SOFR would only be available at the end of the relevant computation period, the value of Fallback Rate (SOR) would likewise be known only a few days before interest payment dates. In other words, Fallback Rate (SOR) is a “backward-looking rate”, similar to the proposed fallback reference rates for LIBOR contracts such as Fallback Rate (SOFR) or Fallback Rate (SONIA). This is different from SOR, LIBOR and other IBOR rates, which are “forward-looking rates” that embed a term premium and are typically available well ahead of interest payment dates. The switch from forward- to backward-looking reference rates will have implications on a range of processes from settlement, to accounting, and risk management, which market participants should be prepared for.

  • SC-STS would like to emphasise that Fallback Rate (SOR) should be used only as an interim fallback solution for residual SOR contracts that remain outstanding after end-2021. Fallback Rate (SOR) will be discontinued after about three years following the fallback trigger, during which time market participants should seek to transition legacy contracts to SORA as soon as possible. Market participants are strongly discouraged from entering into new contracts that reference Fallback Rate (SOR), as it is only intended to facilitate the winding down of legacy SOR contracts where needed.

  • For avoidance of doubt, “Adjusted SOR” is the original name of Fallback Rate (SOR) and has been used in several document references posted here. “Adjusted SOR” was renamed to “Fallback Rate (SOR)” in the ISDA’s IBOR Fallback Supplement and IBOR Fallback Protocol, with no change in meaning or computation methdology.

Additional Context for the Permanent Discontinuation of SOR

  • As highlighted above, SOR relies on USD LIBOR in its computation, and will be permanently discontinued when USD LIBOR is permanently discontinued after end-2021. In addition, SC-STS had reviewed the global adoption of pre-cessation triggers for contracts referencing LIBOR3, and has proposed to ABS Co. that SOR should be discontinued when USD LIBOR is declared non-representative. This will avoid the use of a non-representative USD rate as input, and also help align fallback triggers across contracts with and without such pre-cessation triggers incorporated.

  • An exception to this permanent discontinuation of SOR will occur when a particular tenor of USD LIBOR which has been permanently discontinued or is declared non-representative can be replaced by a linear interpolation of two adjacent USD LIBOR tenors that are not non-representative.

    • In such an event, ABS Co will continue to publish SOR based on the interpolated USD LIBOR. Such SOR rates will be accompanied by a footnote on the screens where they are published, to indicate the use of an interpolated USD LIBOR in the computation of an affected SGD SOR tenor.

    • This approach to the use of an interpolated USD LIBOR rate is aligned to the contractual fallback language in ISDA’s IBOR Fallback Supplement. This provides that contracts referencing USD LIBOR should reference a rate based on interpolation of adjacent tenors of USD LIBOR, if a particular tenor of USD LIBOR has been permanently discontinued4.

    • SOR will be discontinued when such interpolation is no longer possible i.e. when there are no available USD LIBOR tenors, both longer and shorter than the discontinued tenor. In the event, the relevant contractual fallbacks will then apply.

3 A pre-cessation trigger will trigger the contractual fallback to a LIBOR-referencing contract when LIBOR is found by UK FCA to be non-representative. Incorporation of pre-cessation triggers means that contractual fallbacks are triggered either by the permanent discontinuation of a LIBOR rate, or when the LIBOR rate is declared non-representative.


4 Refer to Section 8.5 (Discontinued Rates Maturities) of the proposed Supplement on Amendments to the 2006 ISDA Definitions to include new IBOR fallbacks.