As explained in the previous article, the Interest Rate Benchmark Reform triggered by the LIBOR scandal has forced Japan to establish a reliable interest rate benchmark to replace the JPY LIBOR.
And TORF was born. This time, we will introduce TORF in detail.
Publication of TORF
In May 2020, QUICK, which was deemed appropriate for the administration of the term risk free rate, began to publish prototype rates without assuming their use in transactions. In July, QUICK announced the name TORF (Tokyo Term Risk Free Rate), and in January 2021, the company established QUICK Benchmarks Inc. (QBS), which is responsible for the actual calculation and publication of TORF. In April, QBS started to announce TORF production rate with the conditions used for transactions.
On the day after the publication, TORF was designated as a Specified Financial Benchmark by the Financial Services Agency of Japan, and QBS was also designated as a Specified Financial Benchmark Calculator.
Three Reasons Why You Should Choose TORF
TORF, which has thus started to be published, performs a part in the multiple rate approach as a term risk free rate, together with TONA, an interest rate benchmark as a risk free rate, and TIBOR, an interest rate benchmark that includes credit risk.
Users can choose from these three types of interest rate benchmarks and use the one they think is most appropriate for the transaction. So when do they choose TORF?
The first reason for choosing TORF is that TORF adopts “fixing in advance” that the applicable interest rate is fixed at the beginning of the term. “Fixing in advance” is more intuitively acceptable than “fixing in arrears,” and non-financial people are familiar with it. To manage financial assets by unifying the underlying exposure and several related transactions into TORF, “fixing in advance” is convenient. It should be noted that while there are restrictions on the use of “fixing in advance” term risk free rates in North America and the United Kingdom, there are no such restrictions in Japan and it is left to the discretion of the user.
The second reason is that the definition of TORF has been standardized with LIBOR except for some parts, so the existing system can be adapted with minor modifications. While it is natural that TORF was designed for the purpose of migrating from LIBOR, this feature contributes to the smooth migration from LIBOR because it reduces the burden not only on the system and other hardware, but also on the operators who are actually engaged in the work.
Thirdly, TORF is more robust because it is calculated based on the execution data observed in the market, rather than the “submission” type used by the conventional LIBOR.
Japan’s Unique Market Practices and Future-Proofing Mechanisms
By the way, there are several interest rate benchmarks in the world that are calculated based on data observed in the market, but in most cases, only electronic market data is used.
However, as Japan is a market dominated by non-electronic transactions such as voice brokerage, benchmarks based solely on electronic market data may not be representative of market movements. In response, QUICK has established a network to collect data from voice broker companies that conduct non-electronic transactions, and has also succeeded in significantly automating the subsequent processing. It was a difficult project to cross-cut both the unique internal systems of the voice brokers and the unique rules used by them. However, a system that captures almost 100% of the transactions subject to TORF calculation has been created.
In addition, the second layer of Waterfall Methodology in the TORF calculation rule is configured to collect data from markets that have already been electric, making it possible to flexibly incorporate developments in electronics and continue calculations in the future. As a result, we believe that TORF will be able to achieve stable publication of its calculations over the long term.
Since the launch of TORF with these features, there have been numerous applications for use of TORF not only from leading financial institutions in Japan but also from overseas entities with exposure to Japanese yen. The number of users is expected to increase further next year after the suspension of the JPY LIBOR publication.
Back to Story of JPY LIBOR Transition (1)
For more details about TORF
https://corporate.quick.co.jp/en/torf/
