ISDA: unclear if the fallback will be workable [...]
More than one year after my initial explicit question about the achievability of one of the fallbacks proposed by ISDA, ISDA has finally acknowledge that is is unclear if the compounding setting in arrears proposed will be workable.
I have to add a little bit of context around that statement. During the 19 June 2019 webcast by ISDA about the consultations in progress, a certain number of questions from the audience were answered. One of those questions was "How will the fallback apply to IBOR in-arrears swaps?" (at 52:30) Unfortunately I don't have the name of the person who asked the question (and so I cannot acknowledge its source), but I want to thank him/her to have asked the question and congratulate him to have obtained an answer. I have not been able to obtain such an answer since I asked the question more than one year ago. In its answer, ISDA acknowledges that "That does remain an open issue and will remain an issue after the consultation closes" and also "Just as a caveat, it is unclear if the fallback will be workable for those type of products".
Its means that the fallback is entering into the troubled waters of inconsistency. This is the first step in the direction of LIBOR fallback which depend not only on LIBOR and its fixing date but also on where it is used. My rule was "LIBOR means LIBOR", but it appears it is not the rule for all. You may thing that your are hedged, LIBOR payment for LIBOR payment, but you may soon discover that different LIBOR payments, maybe related to the same LIBOR in the same swap, are treated differently!
The question and the answer were related to in-arrears swaps. What is an in-arrears swap payment? There are several way to define it, but let me use the following definition: a LIBOR swap payment is called in-arrears if the period of the underlying LIBOR theoretical deposit finishes in-arrears of the payment date, i.e. the maturity date of the deposit is strictly after the payment date. This is probably not the most standard definition but this definition covers the type of products to which the question refers, i.e. the products for which you don't know the compounding setting in arrears rate on the payment date. Using that definition of in-arrears, many plain vanilla IRS are in-arrears swaps. This is due to non-good business day adjustments. I have described the details of the mechanism in my quant perspective and the earlier version of my fallback notes.
Are we back to square one? LIBOR may be discontinued, we need a fallback, but the fallback is not workable/achievable. Do we need another fallback, not to LIBOR this time but to the consultation on LIBOR? Can someone else propose a fallback consultation, this time with a workable and consistent solution?
At least now everybody seems in agreement: the compounding setting in arrears proposal is not workable/achievable for some products. We may not have yet the same list of products affected, but it is a good starting point for the discussion. Maybe this fact should have been written in the list of potential disadvantages in the consultation document.
The consultation includes the following question about the compounding in arrears:
I have to add a little bit of context around that statement. During the 19 June 2019 webcast by ISDA about the consultations in progress, a certain number of questions from the audience were answered. One of those questions was "How will the fallback apply to IBOR in-arrears swaps?" (at 52:30) Unfortunately I don't have the name of the person who asked the question (and so I cannot acknowledge its source), but I want to thank him/her to have asked the question and congratulate him to have obtained an answer. I have not been able to obtain such an answer since I asked the question more than one year ago. In its answer, ISDA acknowledges that "That does remain an open issue and will remain an issue after the consultation closes" and also "Just as a caveat, it is unclear if the fallback will be workable for those type of products".
Its means that the fallback is entering into the troubled waters of inconsistency. This is the first step in the direction of LIBOR fallback which depend not only on LIBOR and its fixing date but also on where it is used. My rule was "LIBOR means LIBOR", but it appears it is not the rule for all. You may thing that your are hedged, LIBOR payment for LIBOR payment, but you may soon discover that different LIBOR payments, maybe related to the same LIBOR in the same swap, are treated differently!
The question and the answer were related to in-arrears swaps. What is an in-arrears swap payment? There are several way to define it, but let me use the following definition: a LIBOR swap payment is called in-arrears if the period of the underlying LIBOR theoretical deposit finishes in-arrears of the payment date, i.e. the maturity date of the deposit is strictly after the payment date. This is probably not the most standard definition but this definition covers the type of products to which the question refers, i.e. the products for which you don't know the compounding setting in arrears rate on the payment date. Using that definition of in-arrears, many plain vanilla IRS are in-arrears swaps. This is due to non-good business day adjustments. I have described the details of the mechanism in my quant perspective and the earlier version of my fallback notes.
Are we back to square one? LIBOR may be discontinued, we need a fallback, but the fallback is not workable/achievable. Do we need another fallback, not to LIBOR this time but to the consultation on LIBOR? Can someone else propose a fallback consultation, this time with a workable and consistent solution?
At least now everybody seems in agreement: the compounding setting in arrears proposal is not workable/achievable for some products. We may not have yet the same list of products affected, but it is a good starting point for the discussion. Maybe this fact should have been written in the list of potential disadvantages in the consultation document.
The consultation includes the following question about the compounding in arrears:
If you would not be able to transact please give specific examples of the types of derivatives for which the fallbacks would be problematic and explain why.I can already provide (part) of my answer to that question:
We are not aware of any product that will not be problematic.The explanation can be found in my numerous previous notes and blogs and will be summarized in the answer.
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