30 May 2022
On 18 May 2022, the Monetary Authority of Singapore (“MAS”) and the Steering Committee for SOR & SIBOR Transition to SORA (“SC-STS”) jointly announced an SC-STS consultation on adjustment spreads that will apply to legacy Swap Offer Rate (“SOR”) business loans and derivatives. The consultation covers the setting of the MAS Recommended Rate to provide contractual certainty for SOR contracts that remain outstanding after 31 December 2024, and supplementary guidance to support the on-going transition of legacy SOR contracts in wholesale markets. This consultation closes on 10 June 2022. Details are set out below.
The conversion of a legacy SOR contract in wholesale markets to a Singapore Overnight Rate Average (“SORA”)-based contract requires an adjustment spread, which represents the price that a SOR borrower transitioning to SORA would pay over the SORA benchmark rate. The adjustment spreads account for structural differences between SOR and Compounded SORA, such as the credit and term premia absent in SORA. MAS states that in the past year, wholesale market participants were able to rely on a liquid SOR-SORA basis swap market to price these adjustment spreads. However, with the bulk of SOR-based derivatives transitioned to SORA, liquidity in the SOR-SORA basis swap market is declining, resulting in difficulties in pricing the adjustment spreads.
Therefore, MAS has endorsed SC-STS to make and finalise recommendations towards setting the MAS Recommended Rate, including the appropriate calculation methodology for the adjustment spreads to be used. This will apply as a fallback rate for outstanding SOR-based business loans and derivatives that mature after end-2024. Separately, the SC-STS will also provide supplementary guidance on adjustments spreads to apply for interest rate periods before end-2024, to support the industry’s ongoing active transition of wholesale SOR contracts.
Consultation paper recommendations
The SC-STS consultation paper, Consultation on Adjustment Spreads for the Conversion of Legacy SOR Contracts to SORA, sets out the following key recommendations:
- The MAS Recommended Rate should be based on Compounded SORA, given that SORA is now the main interest rate benchmark for Singapore Dollar (SGD) financial markets.
- Adjustment spreads within the MAS Recommended Rate should be derived from the historical median spread between SOR and SORA. The consultation paper states that such a methodology is transparent, verifiable and readily available, and simple to explain and implement. It is also in line with market expectations of the SOR-SORA spreads after end-2024. Together with the linear interpolation outlined in the supplementary guidance, the historical median approach will serve to reduce inequity or unintended value transfer among different participants to the same contract, that may arise from a conversion from SOR to SORA.
- Adjustment spreads for the period before end-2024 should be based on a linear interpolation between a reference spread based on a recent shorter historical median (e.g. 6M) of the SOR-SORA spread and the adjustment spread within the MAS Recommended Rate. To provide certainty in transition outcomes while minimising valuation impact, the SC-STS has proposed flexibility in the application of its recommendations to the active transition of SOR-based derivatives-linked products.