ICE Term Risk Free Rates
I will start with my usual rant about "risk free". SONIA is based on unsecured transaction and is credit risky. Not risk free on the credit side. A term rate is, as its name says, fixed for a term and the value of a term instrument changes when the market changes during that term. Not risk free on the market side. I cannot understand why this incorrect terminology of "risk free" is so widely used while plenty of correct and more meaningful terminology are available: collateralised rate, overnight-linked rate, overnight-indexed rate, derivative term rate, alternative rate (I don't like alternative rate too much either, it opposes the current name to a previous approach instead of positively describing the present, but it is better than risk free),
IBA (ICE (InterContinental Exchange) Benchmark Administration; I like those acronyms based on acronyms) is launching a "ICE term RFR". The term rate is based on futures prices. The first version is SONIA-linked.
As a reference term rate, I would prefer, as I mentioned in my "Quant Perspective on IBOR Fallback Proposal", a benchmark based directly on OIS than one constructed, through a curve model, with futures. Contrarily to what is indicated in the ICE paper on term risk free rates, the transaction data do not need a "financial model to generate yield curves" if OIS rates of the correct tenor are directly used. The model is required mainly in the futures case.
Regarding OIS, the ICE paper indicates the prevalence of forward starting and MPC meeting OIS. It would be good to have clear statistics on how much is traded on 1, 3, 6-month tenors and other dates.
The futures daily volume is around 4bn. This is below the 40 to 50bn of ON depo that are used for SONIA itself. This is a decent number. The paper claim that the "data is available", but is it "freely available to all market participants and researchers"? I don't thing so (at least I have not found the data yet). My request for benchmarks has been for a long time total transparency. To be totally useful and informative, the "ICE term portal" should provide the detailed futures data on which the term rate is based (and if possible without several layers of legal agreements).
Even if I started with not extremely positive remarks, to my opinion this is a good proposal. This is a benchmark that would be available in London morning (at least its intraday version). GBP LIBOR fallback would be improved if the fallback (term) rates are available shortly after 11:00 am London time, like LIBOR itself. In the waiting for a more robust OIS benchmark, this would be a good starting point. It could be used as the first waterfall step of a multi-stage fallback as proposed in the Section 6.11 of my perspective.
IBA analysis of the usefulness of a "term RFR" is similar to some extend to the one I have developed in my "quant perspective" (Section 3.5), except that they do not mention the LIBOR fallback issue in their note. To my opinion the fallback is where their proposed futures-based term rate could be useful as it would be immediately available. I think it cannot replace an actual OIS based benchmark for term rates on which the most liquid derivatives would be based as the subjective model part could have a large impact.
For the methodology itself, it is based on a quite standard curve calibration with overnight forward rate following a step function between MPC meetings. Such a mechanism is for example described in my multi-curve book in Section 5.11. On top of this there is an arbitrary 1st of month jump in months without MPC meetings. Any other day of the month would be as good in theory. In practice, a mid month would probably be better to avoid too short constant rate periods. When a MPC meeting is on 22th March, there are only 9 days to month-end. Even better than mid-month, it could be slightly earlier to be on average in between the two MPC meetings or month specific to be equal distance of the two surrounding meetings once the actual dates are known. The curve calibration process used for the benchmark is a simplified version of what one would like to use for market making on short term OIS as it does not take into account the intra-month seasonality.
For example in GBP SONIA, the year end and quarter end have usually rate fixing lower that surrounding dates. The year end has seen jumps up to 12 bps in the last years. With year-end being 4 days on 4 years out of 7, this is nor a negligible figure. If we look at SOFR data, there is a clear intra-month seasonality — end-of-month and around 15th of the month have higher rates. A simple flat overnight rate interpolation between FOMC meetings is not good enough. This subjective data will have an important impact.
Wait and see if there is any interest for it from regulators or from ISDA for the IBOR definition fallback.
IBA (ICE (InterContinental Exchange) Benchmark Administration; I like those acronyms based on acronyms) is launching a "ICE term RFR". The term rate is based on futures prices. The first version is SONIA-linked.
As a reference term rate, I would prefer, as I mentioned in my "Quant Perspective on IBOR Fallback Proposal", a benchmark based directly on OIS than one constructed, through a curve model, with futures. Contrarily to what is indicated in the ICE paper on term risk free rates, the transaction data do not need a "financial model to generate yield curves" if OIS rates of the correct tenor are directly used. The model is required mainly in the futures case.
Regarding OIS, the ICE paper indicates the prevalence of forward starting and MPC meeting OIS. It would be good to have clear statistics on how much is traded on 1, 3, 6-month tenors and other dates.
The futures daily volume is around 4bn. This is below the 40 to 50bn of ON depo that are used for SONIA itself. This is a decent number. The paper claim that the "data is available", but is it "freely available to all market participants and researchers"? I don't thing so (at least I have not found the data yet). My request for benchmarks has been for a long time total transparency. To be totally useful and informative, the "ICE term portal" should provide the detailed futures data on which the term rate is based (and if possible without several layers of legal agreements).
Even if I started with not extremely positive remarks, to my opinion this is a good proposal. This is a benchmark that would be available in London morning (at least its intraday version). GBP LIBOR fallback would be improved if the fallback (term) rates are available shortly after 11:00 am London time, like LIBOR itself. In the waiting for a more robust OIS benchmark, this would be a good starting point. It could be used as the first waterfall step of a multi-stage fallback as proposed in the Section 6.11 of my perspective.
IBA analysis of the usefulness of a "term RFR" is similar to some extend to the one I have developed in my "quant perspective" (Section 3.5), except that they do not mention the LIBOR fallback issue in their note. To my opinion the fallback is where their proposed futures-based term rate could be useful as it would be immediately available. I think it cannot replace an actual OIS based benchmark for term rates on which the most liquid derivatives would be based as the subjective model part could have a large impact.
For the methodology itself, it is based on a quite standard curve calibration with overnight forward rate following a step function between MPC meetings. Such a mechanism is for example described in my multi-curve book in Section 5.11. On top of this there is an arbitrary 1st of month jump in months without MPC meetings. Any other day of the month would be as good in theory. In practice, a mid month would probably be better to avoid too short constant rate periods. When a MPC meeting is on 22th March, there are only 9 days to month-end. Even better than mid-month, it could be slightly earlier to be on average in between the two MPC meetings or month specific to be equal distance of the two surrounding meetings once the actual dates are known. The curve calibration process used for the benchmark is a simplified version of what one would like to use for market making on short term OIS as it does not take into account the intra-month seasonality.
For example in GBP SONIA, the year end and quarter end have usually rate fixing lower that surrounding dates. The year end has seen jumps up to 12 bps in the last years. With year-end being 4 days on 4 years out of 7, this is nor a negligible figure. If we look at SOFR data, there is a clear intra-month seasonality — end-of-month and around 15th of the month have higher rates. A simple flat overnight rate interpolation between FOMC meetings is not good enough. This subjective data will have an important impact.
Wait and see if there is any interest for it from regulators or from ISDA for the IBOR definition fallback.
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