Asia DCM: Sofr transition needs fresh push
The transition of Asia’s capital markets away from Libor got a small boost recently when Korea Development Bank sold the region’s second public dollar bond linked to the new benchmark lending rate, Sofr. But the pace of change is not fast enough.
KDB's three year bond linked to the secured overnight finance rate (Sofr), which also came with a green label, raised $300m last week, making it a modestly sized trade. But achieving size was not a critical objective for the deal. Instead, KDB wanted to establish itself as an issuer in the Sofr market and pave the way for other South Korean borrowers to follow.
This is a critical development for, not just Korea’s, but also Asia’s capital markets, as issuers have yet to start fully embracing Sofr, the lending rate that will replace the US dollar Libor when it is phased out. Publication of one week and two month Libor rates will end in December and Libor rates for the remaining tenors will be phased out in 2023.
Despite this pressing deadline, Asian borrowers have been slow to adapt to Sofr.
Bank of China sold the first, and only other, public Sofr bond from Asia in October 2019. BOC's deal was expected to open the market for bonds using Sofr, but challenges around the trade meant other borrowers have been wary of testing the waters. Some issuers have dabbled in private placements, but the consensus among DCM bankers GlobalCapital Asia spoke to this month is that Asian borrowers are still ill-prepared to make the switch.
However, now is a good time for the Asian market to begin accepting Sofr.
KDB's trade showed two important things: that the investor base, particularly in the US, is slowly but steadily warming up to Sofr bonds, and that there is growing demand for floating rate notes (FRNs).
US Treasury rates have been climbing this year, making FRNs back in favour again. The 10 year Treasury closed at 1.59% on Monday, up from where it started the year at 0.93%. Last year may have presented little opportunity to sell FRNs, but bankers believe 2021 could see more floating rate bonds amid volatility.
As borrowers look to sell FRNs, Sofr, instead of Libor, should be a central part of their conversations.
Here, it is the responsibility of the DCM and syndicate teams to offer the right advice. If Asian borrowers are not ready to sell Sofr bonds yet, more education must be done to make them comfortable with the benchmark. After all, their transition to Sofr from Libor is a matter of when, not if, so it is their advisers’ responsibility to have thorough conversations now to lay the groundwork for the move.
Waiting until the deadline is imminent will not do any good. Instead, issuers and banks need to take the bull by the horns while there is still time to approach the switch in a comprehensive way.
The bond market can take lessons from the developments in Asia’s loan market.
There have been notable efforts from the Asia Pacific Loan Market Association and other bodies to aid the transition to Sofr, including providing a switch document template for borrowers and banks. The ICE Benchmark Administration also recently launched a dollar reference webpage with more information about Libor transition. While Asia’s loan market is yet to see a syndicated deal referencing Sofr, a number of bilateral and club-style deals have been closed using the new rate.
These examples from Asia, plus those from the west including the World Bank’s February Sofr bond, should offer potential issuers more clarity about the transition. Asia’s syndicate teams need to dig deeper to find the right solutions for their clients.
It is understandable that borrowers may be concerned about Sofr. Investors, too, will have questions about the new benchmark for the foreseeable future. But instead of kicking the can down the road, issuers and DCM bankers need to come together to make Sofr-linked deals the new normal — before time runs out.