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The People's Bank of China Publishes the White Paper Participating in International Benchmark Interest Rate Reform and Improving China's Benchmark Interest Rate System

Source: The People's Bank of China Updated: 2020-08-31

On August 31, 2020, the People's Bank of China publishes the White Paper Participating in International Benchmark Interest Rate Reform and Improving China's Benchmark Interest Rate System

The Fourth Plenary Session of the 19th Central Committee of the CPC proposed to improve the benchmark interest rates and market-based interest rate system. As an important pricing reference for various financial products, the benchmark interest rate is an important financial market element and core link in monetary policy transmission. Improving the benchmark interest rate system is not only the key to the construction of financial market, but also an important part of deepening the market-oriented interest rate reform, and is of great significance for improving monetary policy management and transmission mechanism.

In global financial market, the most widely used benchmark interest rate is the London Interbank Offered Rate (LIBOR). Since the global financial crisis in 2008, the unsecured interbank lending markets worldwide have significantly shrunk, which weakened reference base for LIBOR quotes. In particular, during the global financial crisis, multiple cases of LIBOR manipulation were exposed, and as a result, market credibility of LIBOR has been severely weakened. Since then, the administrators of LIBOR have launched a series of reform measures, but still unable to regain wide market recognitions. In 2017, the Financial Conduct Authority (FCA) announced that, it will no longer persuade, or compel, banks to submit to LIBOR beyond the end of 2021, which means that exit of LIBOR from the market by then becomes highly likely. 

In response to the possible discontinuation of LIBOR, major developed economies are actively promoting benchmark interest rate reforms and, so far have basically concluded the selection of alternative reference rates. New benchmark interest rates selected by these economies are mostly risk-free rates (RFRs) published independently by each economy. Those rates are based on actual transactions, with a single tenor of overnight, and mostly administered by central banks. For instance, the U.S., UK, Eurozone, and Japan have identified the Secured Overnight Financing Rate (SOFR), Sterling Overnight Index Average (SONIA), Euro Short-Term Rate (€STR), and Tokyo Overnight Average Rate (TONA), respectively.

Considering the fact that new benchmark interest rates are of a single tenor of overnight, the global community is studying on constructing term rates, mainly through two methodologies. First, the backward-looking approach, that is, to refer to the overnight benchmark interest rates that have been produced to calculate their simple or compounded averages as the term rates. Second, the forward-looking approach, under which the term rates will be calculated based on relevant interest rate derivatives transactions. While a number of institutions are studying on developing forward-looking term rates, the backward-looking approach, which has a more robust transaction basis, has received more attention at present. In the meantime, relevant parties are actively promoting the application of new benchmark interest rates as well as the transition from the old benchmarks to the new ones. At the moment, transition arrangements for new and legacy derivatives contracts have been basically determined, and those for new cash products have already been released, while the transition arrangements for legacy cash products have not been clearly clarified.

Domestic banks in China also carry out foreign currency businesses referenced to USD LIBOR, etc., and now face the same problem of LIBOR transition. The People's Bank of China (PBC) has actively participated in international benchmark interest rate reform, and guided the Self-regulatory Mechanism for Market Rate Pricing in setting up a special working group as well as carrying out a series of research. By now it has been made clear that international benchmark interest rate transitions, including LIBOR, etc., in domestic market will follow the general idea of mainly referring to international consensus and best practices, and actively promote the application of new benchmark interest rates. In accordance with that general idea, the PBC has instructed the development of the roadmap and the timetable with respect to the benchmark transitions in domestic market, organized in-depth research and instructed relevant banks to initiate preparation for benchmark transitions as soon as possible. These preparations include participating in the design and application of new benchmark interest rates, promoting benchmark transitions of new contracts, and exploring the benchmark transition arrangements for the legacy contracts.

Although China started late, compared internationally, in building benchmark interest rate system, we have the obvious first-mover advantage in cultivating benchmark interest rates based on actual transactions. Since the establishment of China interbank market, we have already cultivated benchmark interest rates based on actual transactions such as bond repo rates, which have shown a certain level of benchmarking and credibility and have been in operation for over two decades. After years of continuous cultivation, by now significant progress has been made in the construction of China's benchmark interest rate system. Money market, bond mark, loan market, etc., have basically cultivated their own representative interest rate indicators. Depository-Institutions Repo Rate (DR), government bond yield, Loan Prime Rate (LPR), etc., have played a significant role as benchmark interest rates in corresponding financial market, providing relatively good reference in observing market operation and guiding financial product pricing.

Overall, China's benchmark interest rates based on actual transactions have been in operation for a long time, and China possesses full-scale market transaction data with transparency and availability. In addition, the PBC consistently attaches great importance on the regulatory management of benchmark interest rates. These features have established solid foundation for the construction of China's benchmark interest rates, and are conducive to ensuring the credibility, authority and market recognition of each benchmark interest rate.

As the market-oriented interest rate reform further advanced, a sounder benchmark interest rate system is required. Therefore, the PBC has made in-depth research and, proposed ideas and plans on improving China's benchmark interest rates and the market-based interest rate system with the focus on DR. Next, the development priority of China's interbank benchmark interest rate system is to promote wide application of various benchmark interest rates. Efforts will be made in innovating and broadening the application of DR in financial products, including floating-rate bonds and floating-rate interbank certificate of deposits (CDs), etc., so as to make DR a key reference indicator for China's monetary policy management and financial market pricing.

In order to give a comprehensive introduction to China's progress and plan to participate in international benchmark interest rate reform, to summarize current development of China's benchmark interest rate system, and to study and further promote the soundness of the benchmark interest rate system, the PBC hereby publishes this White Paper.

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Attachment: Participating in International Benchmark Interest Rate Reform and Improving China's Benchmark Interest Rate System.pdf