On 2 July 2019, Japan’s Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks (JCIC) comprising leading banks and market participants active in Japan and convened by the Bank of Japan launched its public consultation on the Appropriate Choice and Usage of Japanese Yen Benchmarks. The consultation document can be found here.
The focus of the consultation is to gather views on the possible options for transition from Japanese Yen LIBOR (JPY LIBOR) on or before 2021. Given the work that ISDA has already completed with respect to LIBOR transition, the consultation focuses primarily on challenges for the loan and bond markets.
The JCIC consultation discusses the development of a term risk free rate based upon the uncollateralised overnight call rate (the so called Tokyo Overnight Average Rate or TONAR) as a potential substitute for JPY LIBOR. However it notes that there are challenges to the development of such a term rate, notably that at present trading in TONAR futures (which could provide a possible data source for the development of such a rate) is currently suspended. It also notes that any such term rate would need to be compliant with the IOSCO Principles. The establishment of a term Yen risk free rate could take time to develop and may not be ready by the point at which LIBOR ceases to be published or is otherwise no longer viable as a benchmark.
In the absence of a term risk free rate for Yen, market participants could also consider alternative options either as a temporary measure pending the development of the term risk free rate for Japanese Yen or as a more permanent solution. One such option is the use of the Tokyo Interbank Offered Rate (TIBOR). It closely replicates LIBOR in that it is forward looking and incorporates an element of bank and term credit risk. However, the consultation notes that there is international momentum towards the use of risk free rates rather than IBORs.
The consultation discusses transition to TONAR calculated on a compounded or simple average basis using the “Lock out”, “Delay” or “Reset days prior” methodology. It notes however that transition to this alternative would involve substantial changes to banks’ operational systems and is therefore not likely to be undertaken on a temporary basis. It also notes that use of the compounded in arrears approach would be consistent with similar proposals in other currency jurisdictions and also with the results of the recent ISDA benchmark fallbacks consultations.
As with similar consultations in other benchmark currency jurisdictions the need to preserve equivalent economics by means of a spread adjustment when transitioning to a risk free rate is another theme of the consultation. The consultation notes the benefit of alignment with fallbacks for ISDA derivatives for hedged transactions and that the “historical mean/median” approach to spread adjustment was favoured by a majority of respondents in the recent ISDA consultation. However, it highlights that this method is dependent on there being a sufficient amount of historic and transparent data for the risk free rate in order to be able to make a meaningful comparison between that rate and LIBOR for an equivalent period. As such it indicates that this method may be less appropriate for use on transition to a newly developed term risk free rate.
Responses to the consultation are requested by 30 September 2019.