Global | Publication | April 2020
This article first appeared in the March 2020 issue of Butterworths Journal of International Banking and Financial Law.
This article examines global benchmark reform in the Russian financial market and considers, in particular, the impact of the EU Benchmark Regulation and LIBOR cessation on commonly used Russian benchmarks, such as MosPrime, RUONIA and ROISfix.
LIBOR scandals and global interest rate benchmark reforms have had an obvious effect on the Russian financial market. However, the effect has been relatively small compared to the impact on international financial markets. The reasons for the disproportionate impact are the considerably smaller size of the overall Russian loan portfolio linked to submissions-based benchmarks and the still developing nature of the Russian derivatives market, which has low exposures compared to the global derivatives market.
The high volatility of the MosPrime Rate in the course of the 2008 financial crisis caused a reduction in appetite from market participants for floating rate loans generally. As a result, by the time of the launch of the global interest rate benchmark reform in 2014, Russian market participants had already started to transition away from the submissions-based MosPrime Rate to benchmarks based on transaction data from active underlying markets (such as RUONIA and MIACR which are anchored in overnight markets).
The key rate of the Russian Central Bank (CBR) (the Key Rate) is currently the most frequently used benchmark rate for Roubledenominated floating rate loans and bonds in Russia. The Key Rate is a short-term (one week (1W)) rate administered by the CBR, with a non-market, non-traded nature.
The Russian derivatives market has been influenced by the use of the Key Rate in floating rate loans: the volume of derivatives tied to the Key Rate has been constantly rising. According to the CBR in the Consultation Paper of the Bank of Russia as of September 2019 On financial benchmarks, published on the official website of the CBR on 24 September 2019 (Consultation Paper), as of 1 July 2019, the size of the loan portfolio linked to the Key Rate was 14% of the overall corporate loan portfolio of Russian banks, or 44% of the overall corporate benchmark-linked loans of Russian banks.
The widespread use of the Key Rate in floating rate loans derives from the interest rates shock in 2014, when the CBR drastically raised the Key Rate in response to the collapse of the Russian rouble following the imposition of international sanctions against Russia. The factors that have contributed to the popularity of the Key Rate in financial products include: high volumes of the CBR’s refinancing of Russian banks, with such loans being tied to the Key Rate and, as a result, a high correlation of the Key Rate with banks’ funding costs; transition of Russian banks to floating loans linked to the Key Rate in an effort to meet clients’ expectations on pricing transparency of loans; and provision of state subsidies (in the form of loans tied to the Key Rate) to a number of Russian industry sectors.
The use of the Key Rate poses clear risks for borrowers, especially in long-term products, but the tendency to link financial products to the Key Rate remains in the Russian loan, bond and derivatives markets.
Global interest rate benchmark reform (including the introduction of the European Benchmark Regulation No 2016/1011 (EU BMR) and proposed LIBOR cessation) have had an impact on the Russian market.
After the publication of the IOSCO Principles of Financial Benchmarks in July 2013 and the launch of global interest rate benchmark reform, the CBR took the issues of fair pricing and credibility of Russian benchmark rates seriously and, since 2015, has been developing basic principles of regulation of financial benchmarks in Russia.
These issues have become particularly acute for Russia after the EU BMR came into force in January 2018. According to the EU BMR, all EU-residents are obliged to use only benchmarks approved by EU regulators, including where those benchmarks are provided by benchmark administrators located outside the EU. In other words, after 31 December 2021, European market participants will be prohibited from using Russian benchmarks in their financial instruments, including in cross-border transactions with Russian counterparties, unless such benchmarks and their administrators have been approved for use in the EU before 1 January 2022. Approval must be through one of the approval routes specified in the EU BMR, being endorsement (under Art 33 of the EU BMR), recognition (under Art 32 of the EU BMR) or equivalence (under Art 30 of the EU BMR). However, equivalence is not expected to be available to third-country benchmark administrators before the end of the transition period under the EU BMR. The CBR in the Consultation Paper took the position that equivalence is a lengthy procedure that would require urgent adoption of financial benchmarks regulation in Russia. As such, this approval option would not be considered by the CBR as a priority task going forward.
The CBR and market participants need to determine how to deal with the EU BMR rules and if any Russian benchmarks will be registered in accordance with the requirements of the EU BMR.
The question of registration of Russian benchmarks in accordance with the EU BMR is closely connected with the reform of the MosPrime Rate and the determination of Russian risk-free rates.
With the introduction of the EU BMR, the Russian market needs to determine the range of benchmarks having key relevance for the Russian market and get these benchmarks and their administrators approved in accordance with the EU BMR requirements. There is, however, no consensus among market participants as to what interest rates should be the key benchmark rates for the Russian financial market.
The MosPrime Rate is a Rouble moneymarket reference rate for loans (deposits) offered in the Moscow interbank market and is usually seen as a Russian equivalent of an IBOR reference rate. It is calculated daily for a wide range of tenors (O/N, 1W, 2W, 1M, 2M, 3M and 6M) and formed on the basis of submissions from eight panel banks.
According to the CBR in the Consultation Paper, as of 1 July 2019, the volume of MosPrime linked loans was not significant – 5% of the overall corporate benchmark-linked loans of Russian banks. However, its main domain is the Russian derivatives market where it holds prevailing positions. Based on the data from the Consultation Paper, in 2017 – 2018, the volume of Rouble-denominated interest rate swaps linked to the MosPrime Rate exceeded 70% of the overall number of interest rate swaps in the Russian derivatives market, while the volume of other MosPrime-linked derivatives was close to 100% of the overall numbers.
Before the 2008 financial crisis the MosPrime Rate was the key benchmark rate in the Russian money market. Due to its high volatility during the 2008 financial crisis, the turnover of the MosPrime-linked interbank unsecured market dropped dramatically and never returned. Investors’ low appetite for MosPrime-linked loans was not, however, the only reason why the MosPrime Rate lost its popularity. After the LIBOR scandals, international banks reconsidered their plans to continue contributing to IBOR panels: some of them withdrew from certain IBOR panels, and those who stayed significantly tightened their controls around benchmark submissions. The panel for the MosPrime Rate was not an exception: all Russian subsidiaries of foreign banks (except for UniCredit Bank and Raiffeisen Bank) left the panel of MosPrime contributors and were in part replaced by Russian banks of similar credit rating.
The Russian market does not currently allow the MosPrime panel to increase in size or even regain its historical size. Due to international sanctions imposed on Russia and following the downgrade of the credit ratings of major Russian credit institutions, many banks do not meet the necessary criteria to be a MosPrime contributor. As a result, there seems to be little chance to replenish the MosPrime panel without sacrificing the uniformity of the credit standing of contributing banks.
The shrinkage of the underlying market that the MosPrime Rate measures (ie the market for unsecured interbank term lending), the unrepresentative composition of the MosPrime panel, as well as some other vulnerabilities that are standard for all IBOR rates (such as the inclusion of bank credit risk and submissions of contributing banks not being based on actual transactions) have led Russian market participants to discuss the prospects of reforming the MosPrime Rate or, alternatively, its potential replacement by other benchmark rates.
Currently, there are a number of benchmark rates that meet international market standards for nearly risk-free rates. One of them, RUONIA (Ruble Overnight Index Average), was considered by Russian market participants as the most likely candidate for the replacement of the MosPrime Rate. RUONIA is fully anchored to actual transactions and is calculated by the CBR on the basis of data from 30 submitting banks. It is often seen as the main interest rate in the Russian overnight unsecured interbank market. RUONIA is also actively used as the benchmark rate for Roubledenominated bonds as well as Rouble interest rate swaps. This rate however has only one tenor (overnight) and cannot be used as an alternative for MosPrime-linked instruments with longer tenors without developing term RUONIA rates.
Another benchmark rate which, together with RUONIA, the CBR considers as a key rate for building the risk-free yield curve of the Russian interbank market, is ROISfix (RUONIA Overnight Interest Rate Swap). ROISfix is a reference rate (fixing) for interest rate swaps indexed to RUONIA. As opposed to RUONIA, ROISfix is flexible: it has almost the same tenors as the MosPrime Rate (1W, 2W, 1M, 2M, 3M, 6M and 1 year), but does not have a considerable transaction volume. Most importantly, it is not used for the pricing of loans in the Russian loan market so it would not be an appropriate replacement for the MosPrime Rate.
RUSFAR (Russian Secured Funding Average Rate) is one more benchmark rate which, according to the CBR in the Consultation Paper, has the potential to become an alternative risk-free rate for the Russian repo market. RUSFAR is a reference rate based on data from the Russian repo market relating to repo transactions with central counterparty secured by general collateral certificates. Like the MosPrime Rate, RUSFAR has a wide range of tenors. However, it is not yet clear if it may be used as an alternative to the MosPrime Rate.
The issue of benchmark reform was considered by the CBR and major Russian banks during the September 2019 session of the Expert Council for Benchmarks and Rates (Expert Council) of the National Finance Association (NFA). The NFA is a leading professional association of Russian financial market participants. It was established in 1996 by major Russian banks and investment companies with the support of the Russian Ministry of Finance and the CBR. At the moment the NFA brings together more than 250 Russian financial market participants whose aggregate turnover amounts to 80% of the Russian market.
The Expert Council is a regular working body of the NFA. Its official mission is to collect and analyse data on use and calculation methodology of financial instruments being used by industry participants, including, analysis of use, determination methodologies and governance arrangements with respect to five Russian benchmarks administered by the NFA (ie the MosPrime Rate, RUONIA, ROISfix, RuREPO and the NFEA SWAP Rate). The work of the Expert Council involves active participation of the key players in the Russian financial market – from the CBR and the Moscow Exchange to major Russian banks and industry participants.
The participants of the session came to the conclusion that the MosPrime Rate, RUONIA and ROISfix were of vital importance to the Russian financial market; these rates will need to be registered in accordance with the requirements of the EU BMR; an action plan will need to be developed by the NFA as administrator of these rates to ensure their use in the EU after the expiry of the EU BMR transition period; and that the NFA needs to develop recommendations on how to fix the existing vulnerabilities of the MosPrime Rate.
It remains to be seen whether any effective ways might be found to improve the MosPrime Rate taking into account the existing realities of the Russian financial market, such as the considerably reduced volumes of MosPrime-linked loans, the use of RUONIA as a benchmark in the Russian unsecured interbank market and the low prospects of extension of the MosPrime panel.
At the same time:
There is no current consensus on which Russian benchmarks should be approved under the EU BMR. It might be the case that the list agreed with the CBR in the September 2019 session of the Expert Council will prove to be final and will not change (except for RUONIA) and the views the CBR asked for in its September 2019 consultation paper will be used by the CBR for information only.
Together with the issue of approval of Russian benchmarks under the EU BMR, Russian market participants will face one more challenge after the UK leaves the EU single market and the EU customs union at the end of 2020. As a result of Brexit, Russian market participants will need to have Russian benchmarks and their benchmark administrators approved (registered) under two separate legislative regimes – the one specified in the EU BMR and another one developed by UK regulators. However, it is not known whether Russian market participants have considered the consequences of Brexit.
A separate concern emerged after the UK regulator, the Financial Conduct Authority, announced discontinuation of LIBOR after 2021. The CBR and Russian market participants have had to determine the potential impact of LIBOR replacement and develop an action plan to mitigate risks resulting from such replacement.
The volume of LIBOR-referenced instruments in the Russian market remain significant: firstly, in the Russian derivatives market where, according to the analytical paper of the CBR Review of Risks in the Financial Markets, issue No 2, February 2019, as of the first quarter of 2019, the size of cross-currency and interest rate swaps indexed to LIBOR amounted to 74% of the market and 16% of these swaps had an expiry date after the date of LIBOR cessation.
Second, the size of the LIBOR-based loan portfolio in Russia is significant. Based on the CBR data in the Consultation Paper, as of 1 July 2019, approximately 20% of the overall corporate benchmark-linked loans of Russian banks were LIBOR-indexed loans, which is four times more than the MosPrime-linked loan portfolio.
Accordingly, in the context of LIBOR cessation, Russian market participants have realised the urgency of determining the potential impact of the transition to alternative risk-free rates on their profit margins and existing hedge relationships, as well as of developing an action plan for mitigating risks and adopting standard documentation for LIBOR cessation.
To address the above issues, the NFA (as agreed with the CBR and other major market participants in the July 2019 session of the Expert Council) created a working group with the priority task of tailoring global benchmark reform to the realities of the Russian financial market and handling the issues connected with LIBOR cessation.
At the moment, no specific documents or reports have been published by the NFA in relation to the work done by its LIBOR working group. It remains to be seen what solutions the NFA working group will suggest to the Russian financial market to avoid an erratic and expensive LIBOR transition.
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