HKMA Benchmark Rate Reform: Transitioning from LIBOR to Alternative Reference Rates in Hong Kong

The Hong Kong Monetary Authority (HKMA) has set a hard deadline of 30 June 2025 for the cessation of all remaining Hong Kong dollar (HKD) overnight indexed swap (OIS) and forward rate agreements referencing the Hong Kong Interbank Offered Rate (HIBOR). This action follows the global wind-down of LIBOR, which officially ceased for most tenors on 31 December 2021. For any financial institution in Hong Kong still holding contracts referencing these benchmark rates, the transition to alternative reference rates (ARRs) is no longer a forward-looking compliance project — it is an immediate operational and legal necessity. The HKMA’s 2024 circular on benchmark rate reform made clear that supervised institutions must have completed fallback language incorporation into all new contracts by 31 December 2024. Firms that have not done so face regulatory scrutiny and potential contractual uncertainty. This article outlines the regulatory framework, the available ARRs in the Hong Kong market, and the practical steps for compliance.

The Regulatory Mandate for Benchmark Rate Transition

The HKMA’s Supervisory Expectations

The HKMA has issued a series of supervisory circulars and policy statements on benchmark rate transition since 2020. The most recent, the Supervisory Policy Manual on Benchmark Rate Reform (Module BR-1), published in March 2024, sets out the minimum standards for authorised institutions (AIs) in Hong Kong. The circular requires all AIs to:

• Identify all contracts, including loans, derivatives, and securities, that reference HIBOR or any other benchmark rate scheduled for cessation.
• Incorporate robust fallback language into all new contracts. The HKMA specifies that fallback clauses must reference the relevant ARR as defined by the Hong Kong Monetary Authority’s Treasury Markets Association (TMA).
• Conduct a comprehensive impact assessment of the transition on their balance sheet, risk profile, and capital adequacy.
• Report progress to the HKMA on a quarterly basis, with the final report due by 31 March 2025.

Failure to comply exposes an institution to supervisory action under the Banking Ordinance (Cap. 155), including potential enforcement measures such as fines or restrictions on business operations.

The Role of the Treasury Markets Association (TMA)

The TMA, under the HKMA’s oversight, is the designated body for implementing benchmark rate reform in Hong Kong. The TMA published the Hong Kong Alternative Reference Rate (HKD ARR) Methodology in 2021, which defines the HKD Overnight Index Average (HONIA) as the primary ARR for HKD contracts. HONIA is a transaction-based rate, calculated daily by the HKMA, reflecting the cost of unsecured overnight HKD interbank borrowing.

For contracts that previously referenced USD LIBOR, the TMA has designated the Secured Overnight Financing Rate (SOFR) as the primary ARR. For contracts referencing other tenors of HIBOR that are not being discontinued, the transition is not required, but the HKMA encourages voluntary adoption of ARRs for new business.

The Available Alternative Reference Rates in Hong Kong

HONIA for HKD Contracts

HONIA is the official replacement for the HKD Overnight Indexed Swap rate. It is a backward-looking overnight rate, meaning it is calculated based on actual transactions during the previous day. The HKMA publishes HONIA daily at approximately 11:00 a.m. Hong Kong time. For contracts that previously used a forward-looking term rate, such as 1-month or 3-month HIBOR, the transition requires a shift to a compounded average of HONIA over the relevant period.

The TMA has developed a HONIA Compounded Index to facilitate this calculation. The index is published daily and allows parties to calculate the compounded rate for any given period by taking the ratio of the index values at the start and end of the period. This method is specified in the ISDA 2020 IBOR Fallbacks Protocol and the HKMA’s Standard Fallback Language for HKD Contracts.

SOFR for USD Contracts

For USD-denominated contracts held by Hong Kong institutions, the Federal Reserve Bank of New York’s Secured Overnight Financing Rate (SOFR) is the designated ARR. SOFR is a broad measure of the cost of borrowing cash overnight collateralised by U.S. Treasury securities. It is published daily by the New York Fed.

The HKMA has confirmed that for USD LIBOR-linked contracts, Hong Kong institutions should follow the fallback provisions set out in the ISDA 2020 IBOR Fallbacks Protocol and the ARRC (Alternative Reference Rates Committee) Recommendations. The key difference between SOFR and HONIA is that SOFR is secured, while HONIA is unsecured. This difference can have implications for the pricing and risk characteristics of the replacement contract.

Term SOFR and Term HONIA

While HONIA and SOFR are overnight rates, the market has developed forward-looking term rates to ease the transition for certain product types. The Term SOFR rate is published by the CME Group and is available for 1-month, 3-month, and 6-month tenors. The HKMA has not yet endorsed a Term HONIA rate for general use, but the TMA is consulting on its development. For now, the default for HKD contracts remains the compounded HONIA approach.

Practical Steps for Compliance

Step 1: Conduct a Comprehensive Contract Inventory

The first operational step is to identify every contract in the institution’s portfolio that references a benchmark rate scheduled for cessation. This includes loans, derivatives, bonds, structured products, and any other financial instruments. The HKMA’s Module BR-1 requires this inventory to be completed and documented by 31 December 2024.

The inventory must record:

• The specific benchmark rate referenced (e.g., 3-month HIBOR, 1-month LIBOR).
• The fallback language, if any, already contained in the contract.
• The maturity date of the contract.
• The notional amount and currency.

Step 2: Amend or Replace Contracts Lacking Fallback Language

For contracts that do not contain adequate fallback language, the institution must either amend the contract to incorporate the standard TMA fallback language or replace the contract with a new one referencing the ARR. The HKMA has provided a Standard Fallback Clause for HKD Contracts (published in 2022) that should be used for this purpose.

The amendment process requires bilateral agreement with the counterparty. For derivatives, the ISDA 2020 IBOR Fallbacks Protocol provides a multilateral framework for incorporating fallback language. The HKMA strongly encourages all AIs to adhere to this protocol.

Step 3: Update Risk Management and Valuation Models

The transition to ARRs changes the risk profile of the contracts. Overnight rates are more volatile than term rates, and the compounded calculation introduces a lag in the rate determination. Institutions must update their risk management models to reflect these changes. The HKMA’s Module BR-1 requires AIs to:

• Reassess their interest rate risk in the banking book (IRRBB) under the new ARR regime.
• Update their valuation models for derivatives and other instruments.
• Adjust their capital adequacy calculations, as ARRs may affect the calculation of risk-weighted assets.

Step 4: Train Staff and Update Internal Policies

The transition affects multiple departments, including treasury, risk, legal, and compliance. Institutions must provide training on the new ARRs, the fallback language, and the operational processes for compounded rate calculation. Internal policies and procedures should be updated to reflect the new benchmark rates for all new business.

The HKMA expects AIs to have a dedicated transition team in place, with a named senior manager responsible for the project. This manager must report directly to the board of directors.

The Legal and Documentary Implications

The ISDA 2020 IBOR Fallbacks Protocol

For derivatives, the ISDA 2020 IBOR Fallbacks Protocol is the primary mechanism for incorporating fallback language. The protocol applies to all ISDA Master Agreements and provides a standard fallback that triggers upon the permanent cessation of the relevant benchmark. The fallback for HKD LIBOR is the HONIA compounded rate plus a spread adjustment. The spread adjustment is calculated by ISDA based on the historical difference between the relevant LIBOR tenor and the compounded overnight rate.

Institutions that have not adhered to the protocol should do so immediately. The protocol is administered by ISDA, and adherence is a simple online process. Once adhered, the fallback language is automatically incorporated into all existing ISDA Master Agreements with other adhering parties.

Loan Documentation

For loan agreements, the fallback language must be incorporated directly into the facility agreement. The HKMA’s standard fallback clause provides a template that can be used. The clause specifies that upon the cessation of the reference rate, the rate will be replaced by the HONIA compounded rate plus a credit adjustment spread (CAS). The CAS is intended to compensate for the difference in credit risk between the term HIBOR rate and the overnight HONIA rate.

The TMA has published a Credit Adjustment Spread Methodology that sets out how the CAS should be calculated. The methodology is based on the historical median difference between the relevant HIBOR tenor and the compounded HONIA rate over a five-year lookback period.

Bond and Structured Product Documentation

For bonds and structured products, the fallback language is typically contained in the terms and conditions of the instrument. The HKMA has issued guidance for issuers on how to amend existing bond documentation. For new issuances, the HKMA requires that all bonds listed on the Hong Kong Stock Exchange (HKEX) include fallback language referencing the relevant ARR. This requirement is set out in the HKEX’s Listing Rules (Chapter 11).

Closing Section: Actionable Takeaways

1. Complete your contract inventory by 31 December 2024 — the HKMA’s Module BR-1 sets this as a firm deadline, and failure to do so invites supervisory intervention.
2. Adhere to the ISDA 2020 IBOR Fallbacks Protocol for all derivatives — this is the most efficient way to incorporate fallback language across your derivative portfolio.
3. Use the TMA’s standard fallback clause for all new HKD loan agreements — this ensures consistency with regulatory expectations and reduces negotiation time with counterparties.
4. Update your risk models to account for the volatility of overnight ARRs — the transition changes the interest rate risk profile of your balance sheet and requires recalibration of IRRBB.
5. Designate a senior manager responsible for the transition — the HKMA requires a named individual with direct board reporting lines to oversee the project.

This does not constitute legal advice. Consult a solicitor for your specific case.