On December 10, the Financial Services Commission and the Bank of Korea held the 5^th Benchmark Rate and Short-Term Financial Market Consultation with related organizations, such as the Financial Supervisory Service, the Korea Securities Depository, and the Korea Exchange, as well as academics and market experts, to discuss the “Plan for Promoting Benchmark Rate Reform in 2025.”

Progress of Benchmark Rate Reform in 2024

The benchmark rate is an interest rate that is used to determine the value of money or financial instruments to be paid or exchanged as a result of a financial transaction. It is used to determine the profit or loss of financial transactions, evaluate investment performance, and generally represent the cost of short-term financing for financial institution.

In major countries, the global benchmark rate reform process, triggered by the LIBOR manipulation case in June 2012, firmly established the actual transaction-based risk-free rate (RFR) as the benchmark rate for financial transactions focusing on derivatives transactions. In 2020, Korea enacted the Act on the Management of Financial benchmarks in accordance with the recommendations of international organizations such as the Financial Stability Board, and started calculating the Korea Overnight Financing Repo Rate (KOFR) as a critical benchmark rate in 2021. However, the efforts of the KOFR activation went slowly due to the need to prioritize financial market stability during the global liquidity reduction process that began in 2022.

In 2024, the government and the Bank of Korea began discussions on revitalizing the KOFR based on stable market conditions and formed a joint public-private working group while strengthening communication with market participants. In August 2024, the government and the Bank of Korea announced the principle of transitioning to a KOFR-centered benchmark rate system. Since then, the working group has been discussing the strategy for activating KOFR and plans to implement the strategy in 2025 based on the results discussed so far.

Plan for Promoting the Benchmark Rate Reform in 2025

Derivatives market: Implementation of the strategy to expand KOFR-based Overnight Index Swap (OIS) transactions

The derivatives market, especially the interest rate swap (IRS) market, is a key market where the RFR is most widely used. International organizations recommend the use of the RFR as the reference rate for the derivatives market, and the RFR is also used as the dominant reference rate for the IRS market in major countries (Such as the Secured Overnight Financing Rate (SOFR) in the United States). However, in Korea, almost all interest rate swaps are based on the CD rate, which include credit risk. As a result, reforming the current practices of the derivatives market is the highest priority task to promote the KOFR.

The government, the Bank of Korea, other related organizations, and market participants agreed that a certain portion of new interest rate swap derivatives transactions will be concluded on a KOFR basis starting in 2025 in order to expand the share of KOFR in the derivatives market. As a result, the "KOFR-OIS Trading Promotion Plan" will be implemented in July 2025. Next year, about 29 financial institutions with large volumes in the interest rate swap market will be the first to participate, and they plan to conclude at least 10% of their interest rate swap transactions during the period from July 2025 to June 2026 based on the KOFR. Under the Trading Promotion plan, the KOFR target share will be flexibly increased around 10 percentage points annually, and the range of participating financial institutions will be gradually expanded. As planned, KOFR is expected to represent more than 50% of the interest rate swap market by 2030.

The government, the Bank of Korea, the Financial Supervisory Service, the Korea Exchange, and the Korea Securities Depository plan to implement a number of supportive policies to promote KOFR-OIS. First, a central clearing infrastructure will be established to make it easier for market participants to participate in KOFR-OIS transactions. The Korea Exchange is currently developing a central clearing system for KOFR-OIS and plans to launch the central clearing service in October 2025.

In addition, the Bank of Korea plans to reflect the trading performance of KOFR-based derivatives (futures and swaps), bonds and loans when selecting institutions for open market operations to support the initial liquidity and market formation of KOFR-linked products. In July 2025, the performance from December 2024 to June 2025 will be aggregated and reflected in the selection of institutions for open market operations (repurchase agreements and monetary stabilization bond). Starting in 2026, the annual trading performance of the past year will be reflected.

In order to enhance the financial community's interest in the KOFR and facilitate the gradual transition from the CD rate to the KOFR, the contingency alternative indicator for OTC derivatives contracts based on the CD rate will also be unified into the KOFR. The financial institutions have expressed difficulties in selecting alternative indicators under the Act on the Management of Financial Benchmarks for individual OTC derivatives contracts. As a result, the public-private working group agreed to designate the KOFR as a contingency alternative indicator to the CD rate as a whole, reflecting the financial sectors' opinions. These contents will soon be notified to the International Swaps and Derivatives Association (ISDA) to be reflected in the standard contract. The Financial Services Commission and the Bank of Korea will continue to provide prompt solutions to various difficulties that may arise in the process of promoting the KOFR through the joint public-private working group.

Bond market: Expanding KOFR-FRN financing (public financial institutions and commercial banking sector)

Currently, most of the floating rate linked financing of financial institutions is based on the CD rate. Starting in 2025, financial institutions will utilize the KOFR when raising funds through the bond market. Public financial institutions (Korea Development Bank, Industrial Bank of Korea, and Export-Import Bank of Korea) and commercial banks plan to raise more than 10% of their funding through issuing KOFR-based floating rate notes (KOFR FRNs), and the share of KOFR FRNs will gradually increase in the future. As a result, annual KOFR FRN issuance is expected to reach around KRW3 trillion next year and KRW4-5 trillion in the mid- to long-term.

Discussions will also continue through a joint public-private working group to ensure that KOFR FRNs are actively utilized in the financial market. As KOFR FRNs have different characteristics from existing FRNs, the working group will continue to monitor and discuss whether there are any obstacles to the promotion of KOFR FRNs in issuance, trading, or investment.

Attendee Highlights

At the meeting, Kim Soyoung, Vice Chairman of the Financial Services Commission, said that the efforts of the government, the Bank of Korea, and other related organizations, as well as the active participation of the financial sector, have put the benchmark rate reform on track, that they have been working together with market participants to create a common plan that everyone can agree on, and that they will now move forward to change market practices in accordance with the agreed plan. Vice Chairman Kim further said that enhancing global consistency by joining the trend of international reforming benchmark rates is an important job for managing operational risks in the financial system, and noted that this reforming benchmark rates will be an opportunity to enhance the safety of the Korean financial system.

Ryoo SangDai, Senior Deputy Governor of the Bank of Korea, emphasized that the promotion of the KOFR is very important not only for the development of the domestic financial market, including securing global consistency and strengthening the stability of financial transactions, but also for enhancing the effectiveness of monetary policy, because the KOFR is the interest rate in the short-term money market where the transmission of monetary policy begins and closely linked to the Bank of Korea Base rate. He also thanked the relevant organizations that have been working together to promote the KOFR since the establishment of the public-private working group in March, and noted that the Bank of Korea will continue to actively work with the policy authorities to ensure that the efforts to transition to a KOFR-centered benchmark rate system will lead to visible results by 2025.

Academic and market experts evaluated that the transition to a KOFR-centered benchmark rate is a challenging task that requires changing market practices, but the government and the Bank of Korea have taken a meaningful first step as a result of their active efforts, and requested that the government, the Bank of Korea, and other relevant organizations continue to pay close attention and actively respond to practical issues as the market for KOFR-linked products expands.

* Please refer to the attached PDF for details.