This article first appeared in the March 2020 issue of Butterworths Journal of International Banking and Financial Law.
- LIBOR cessation and global benchmark reform is having an impact on the Russian financial market.
- A working group of the National Finance Association has been tasked with identifying appropriate benchmarks to register in accordance with the requirements of the EU Benchmark Regulation.
- Those might be RUONIA (Ruble Overnight Index Average), ROISfix (RUONIA Overnight Interest Rate Swap) and an improved version of the MosPrime Rate (the Moscow Prime Offered Rate).
- Improving the MosPrime Rate is challenging given the reduced volumes of MosPrimelinked loans, issues with the MosPrime panel and the use of RUONIA as a benchmark in the Russian unsecured interbank market.
- The working group is also considering the impact of LIBOR cessation on the Russian financial market.
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.
The current Russian financial market
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.
The impact of benchmark reform in Russia
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
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.
Alternative Russian risk-free 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:
- with respect to RUONIA, the CBR, as
agreed in the September 2019 session of
the Expert Council, has been considering
whether to become the administrator
of RUONIA (which is currently administered by the NFA). In this event,
RUONIA would have to be carved out
from the scope of the EU BMR (which
does not cover financial benchmarks
administered by central banks); and
- the CBR, in an effort to attract the input
of wider groups of Russian financial
market participants, published its
September 2019 consultation paper on
financial benchmarks, in which it asked
all interested parties to express their views
as to what benchmarks they considered
significant for the Russian market and
which of them would need to be approved
for use in the EU.
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.
What about Brexit?
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.
Impact of LIBOR cessation after 2021
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.