Ever since the 2012 LIBOR scandal rocked the financial world, various initiatives around the world have taken place to improve the integrity and transparency of interest rate benchmarks.  In Korea, the Interest Rate Benchmark Reform Task Force (the “Task Force”) was established around June 2019 with delegates from both the public and private sectors, including the Financial Services Commission (the “FSC”), the Bank of Korea, the Korea Institute of Finance and the Korea Federation of Banks.  The Task Force has been developing (i) policies for the post-LIBOR financial market, (ii) a risk-free interest rate benchmark that could replace LIBOR in the Korean financial market and (iii) other financial benchmarks. 

In July 2017, Andrew Bailey, the chief executive of the Financial Conduct Authority in the UK announced that it will no longer compel panel banks to provide quotations for calculating LIBOR after 2021.  Discontinuing the administration of LIBOR will have far-reaching implications for the world’s financial market, and Korea would be no exception.  As of June 2019, approximately KRW 2 quadrillion worth of financial instruments traded in the Korean financial market were linked to LIBOR, of which KRW 683 trillion will mature after 2021.  However, despite being aware of its magnitude, Korean financial companies have not been able to adequately prepare themselves for the change that lies ahead.

The Task Force has been developing policies that would assist the financial industry with this transition, taking into account the recommendations of the Financial Stability Board (the “FSB”) to improve existing financial benchmarks and develop new ones that could replace the use of LIBOR.   

We summarize their main objectives as follows:

1.   Prepare for discontinuation of LIBOR administration 

The Task Force is recommending market participants to phase out the use of LIBOR for new financial transactions and, if the use of LIBOR is necessary, to include provisions that allow parties to adopt a replacement risk-free benchmark rate.  For financial derivatives, the Task Force recommends market participants to use standard ISDA¹ languages for replacing LIBOR, and for loans and floating rate notes transactions that may not have market standard approaches, the Task Force advises parties to make appropriate amendments to existing contracts. 
 

2.   Develop new risk-free benchmark rate

The FSB recommends the development of a risk-free benchmark rate applicable to financial derivatives transactions and other transactions that factor in the counterparty’s credit risk.  The Task Force is contemplating on potentially using the overnight call loan rate or the overnight repo rate as the risk-free benchmark rate, and is soliciting comments from market participants before its final determination in June 2020. 
 

3.    Management of key financial benchmarks 

Following the FSB’s recommendation that financial regulators develop a policy for calculating key financial benchmarks that would be widely applicable, transparent, fair and reliable for supervisory purposes, Korea will be introducing the Act on the Management of Financial Transaction Benchmarks, which will become effective on November 27, 2020.  Along with its enactment, the FSC will be preparing an enforcement decree that will set forth further details in implementing the provisions of the above law, such as the calculation methods and procedures regarding key financial benchmarks and regulations applicable to the administering agencies. 
 

In 2016, the European Union (the “EU”) enacted its Benchmark Regulations, under which the EU administers its key financial benchmarks.  Under the Benchmark Regulations, the EU will only allow financial transactions to use financial benchmarks that have been recognized by the EU, and therefore, if Korea’s financial benchmark fails to obtain recognition from the EU, there is a risk that Korean financial companies may not be able to enter into financial transactions with parties located within the EU. 

Through the enactment of the Act on the Management of Financial Transaction Benchmarks, the Korean financial regulators will be seeking to gain EU’s recognition with respect to the financial benchmark they develop, and also to strengthen their regulatory supervision over its administration. 

Korean financial companies that have invested in financial instruments linked to LIBOR should assess their risks related to the discontinuation of LIBOR administration, and will need to establish appropriate measures to mitigate such risks.