Benchmark Rate Reform Continues: Over 10% of Interest Rate Swaps to Use KOFR from July

Government and Bank of Korea Continue Benchmark Rate Reform
At Least 10% of Derivatives Interest Rate Swaps to Use KOFR Starting July

Lee Changyong, Governor of the Bank of Korea, is delivering the opening remarks at the policy conference on "Key Tasks and Future Directions for Activating the Domestic Risk-Free Benchmark Interest Rate (KOFR)" held last August at the Bank of Korea in Jung-gu, Seoul. Photo by Kang Jinhyung aymsdream@

The government and the Bank of Korea will launch a full-scale benchmark interest rate reform this year.

The Financial Services Commission, the Financial Supervisory Service, the Bank of Korea, the Korea Securities Depository, and the Korea Exchange announced on May 29 that starting in July, they will promote the execution of at least 10% of interest rate swap transactions in the derivatives market using KOFR (Korea Overnight Financing Repo Rate).

KOFR, the Korea Overnight Financing Repo Rate, is a risk-free benchmark interest rate derived from ultra-short-term rates (such as call rates and repurchase agreement rates) that are based on actual transactions and have sufficient transaction volume, making rate collusion difficult. It was newly established in 2021 in response to criticism that the previously used negotiable certificate of deposit (CD) rate, which served as the main benchmark, did not adequately reflect market interest rates.

Although KOFR calculation has begun, the share of CDs previously used remains high, prompting the government and the Bank of Korea to pursue more active benchmark rate reform. The government explained that while CD yields have long been used in the market and are very familiar to financial institutions and investors, they rely heavily on expert judgment for yield determination due to insufficient underlying trading volume, and they have been repeatedly criticized for failing to reflect changes in market interest rates in a timely manner.

In response, a joint public-private task force last year developed a plan to increase the share of KOFR in the derivatives market. From July this year to June next year, at least 10% of interest rate swap transactions will be based on KOFR, and over the next five years, this share will be raised by 10 percentage points annually.

Twenty-eight financial institutions with large interest rate swap transaction volumes (12 securities firms and 16 banks) will participate. The scope of participating financial institutions will gradually expand each year. If the KOFR adoption plan proceeds smoothly, the share of KOFR-based interest rate swap transactions is expected to exceed 50% by 2030.

In addition, the Korea Exchange is developing a central clearing system for KOFR interest rate swap transactions, targeting a service launch in October this year to make it easier for market participants to engage in KOFR interest rate swap transactions. A recent briefing session was held to gather opinions from market participants, and after mock testing in August and September, the clearing service is scheduled to officially launch in October.

In the bond market, the issuance of KOFR floating rate notes by commercial banks, previously limited to policy financial institutions, will be expanded starting this year. Last year, the joint public-private task force established a plan for policy financial institutions and banks to raise at least 10% of their floating rate note funding based on KOFR starting this year.

A review of floating rate note issuance from January to April this year shows that approximately KRW 1.47 trillion in KOFR floating rate notes were issued, thanks to regular quarterly issuance by policy financial institutions. The share of KOFR-based issuances among all floating rate notes stands at 29.3%. Notably, in May, a commercial bank issued KOFR floating rate notes for the first time, and other commercial banks are preparing to issue KOFR floating rate notes within the second quarter.

The government and the Bank of Korea emphasized that, in line with the benchmark interest rate reform plan already established, they will continue to support the activation of KOFR through the joint public-private task force and inter-agency councils to ensure that market practices are changed without disruption.

This content was produced with the assistance of AI translation services.