By Seunggyu Lim

SEOUL (Reuters) - South Korea plans to announce guidelines to encourage the use of an alternative benchmark in its $4.3 trillion interest rate swap market and replace Certificate of Deposit (CD) rates that currently dominate transactions, two sources said.

The Bank of Korea and the Financial Services Commission are working on transaction guidelines to supplant CD rates with the Korea Overnight Financing Repo rate (KOFR), and at the same time introduce the KOFR-linked Overnight Index Swap market, the sources who were familiar with the matter said.

"The BOK and the FSC will make clear their intention to restrict the use of the CD interest rate when conducting future interest rate swap transactions, although they won't talk about any specific schedules to phase it out," one of the sources told Reuters, asking not to be named due to the sensitivity of the matter.

With the global cessation of the London interbank offered rate, South Korea has been working to develop alternative reference rates locally and address fluctuations in CD rates arising from changes in CD issuances.

In South Korea, 5,874 trillion won ($4.3 trillion) worth of interest rate swap transactions are mostly tied to CD rates, and financial authorities have been working to replace CD rates with the KOFR and prepare the market for the benchmark transition.

Interest rate swaps are trades of a fixed interest rate for a floating rate or vice versa, widely used by investors and banks to hedge risks in financial markets.

CD rates have been South Korea's most widely used reference rates used to determine the cost of borrowing, from interest rate swaps and collateralized loan obligations. ($1 = 1,370.5500 won)