Term rates gain supporters?
It appears that the overnight-based term rates gain more and more supporters. They are already the first step in the fallback language recommended by ARRC for loan, bonds, and secularization.
The term rate solution for fallback was also discussed in an ECB-led consultation on fallback. The majority of the respondents believed that such a term-rate benchmark is not only feasible, but "essential" or "desirable". I discussed it in my blog "Fallbacks consultations: No clash in the answers; clash in questions!"
It appears that the "Federal Reserve’s ARRC representative wrote and requested that ISDA consider a forward-looking rate in its consultation". (1) The consultation started some weeks ago and extend to 12 July 2019.
A recent Risk article, FCA: Sonia derivatives liquid enough to create term rates, quotes Andrew Bailey, the FCA CEO, speaking at a panel session held at the Bank of England.
We are far away from a clear signal from the regulators that only pure overnight fixing is acceptable in the fallback. This "pure overnight signal" seems to be the excuse by ISDA for not including it in the consultations. Maybe if enough participants made their preference clear there will be a review. To my opinion, participants should ignore the limited choices proposed in the consultation and just state their preferred choice(s).
On the term rate in fallback, do we have "ISDA versus the rest of the world"?
In the same article about the BoE panel session, Risk reports
As alluded in some previous blogs (e.g. here), I believe also there is a "potential conduct risk", i.e. a risk of manipulation or trading on material non-public information. In a forthcoming article I will describe the issue in the context of quantitative finance. I will present some of those idea at the Cass Business School workshop on Planning for the end of LIBOR on 19 June 2019.
Note that the the compounded setting in arrears rate and the spread adjustment will be published by an independent third-party vendor selected by ISDA. This means that the adjusted RFR will depend only on the underlying LIBOR dates (as it should) and not on the derivative in which it is used. The lack of measurability due to non-good business days that I described in several documents, including my Quant Perspective, will apply. It is certain that the "compounding setting in arrears" is not achievable.
As I'm at the non-good business day issue, I should mention a USD-LIBOR/SOFR specific issue. The holiday calendar of SOFR (USGS) is not the same as the one for LIBOR (USNY). As described in my "Fallback Transformers" series (a 8 episodes series starting here), this means that an (arbitrary) decision has to be taken on the adjustment of the compounding period. In my production code to analyze large portfolios under fallback scenarios, I have used a "following" rule as this is the standard approach for ON rates. This add to the lack of measurability issue, i.e. the actual rate to be used may be known only two (business) days after its related payment is due.
(1) G. Broyd and D. Wagner. Treliant Industry Insights June, 2019
The term rate solution for fallback was also discussed in an ECB-led consultation on fallback. The majority of the respondents believed that such a term-rate benchmark is not only feasible, but "essential" or "desirable". I discussed it in my blog "Fallbacks consultations: No clash in the answers; clash in questions!"
It appears that the "Federal Reserve’s ARRC representative wrote and requested that ISDA consider a forward-looking rate in its consultation". (1) The consultation started some weeks ago and extend to 12 July 2019.
A recent Risk article, FCA: Sonia derivatives liquid enough to create term rates, quotes Andrew Bailey, the FCA CEO, speaking at a panel session held at the Bank of England.
"I think we do need [a term rate] but we’ve been very clear for a long time now that there are some parts of the market where we need it and that actually there are some parts of the market where it’s not necessary"
Bailey also acknowledged that dealing with legacy Libor-linked products is going to be difficult, and said he wasn’t ruling out any approach to tackling it.
"We’ve known all along that there is a very large legacy and an ongoing legacy [issue] – in some cases the Libor legacy goes on for a century or more. There may be various ways to deal with this and frankly our view on this is that nothing is off the table," he said.
We are far away from a clear signal from the regulators that only pure overnight fixing is acceptable in the fallback. This "pure overnight signal" seems to be the excuse by ISDA for not including it in the consultations. Maybe if enough participants made their preference clear there will be a review. To my opinion, participants should ignore the limited choices proposed in the consultation and just state their preferred choice(s).
On the term rate in fallback, do we have "ISDA versus the rest of the world"?
In the same article about the BoE panel session, Risk reports
In the question-and-answer portion, an audience member raised concerns about the potential conduct risks.
"We’re in the spirit of solving problems. Clearly the transition has to be done carefully and we all – you and us – will have to have a very careful eye on what the implications of this transition are," he said.
As alluded in some previous blogs (e.g. here), I believe also there is a "potential conduct risk", i.e. a risk of manipulation or trading on material non-public information. In a forthcoming article I will describe the issue in the context of quantitative finance. I will present some of those idea at the Cass Business School workshop on Planning for the end of LIBOR on 19 June 2019.
Note that the the compounded setting in arrears rate and the spread adjustment will be published by an independent third-party vendor selected by ISDA. This means that the adjusted RFR will depend only on the underlying LIBOR dates (as it should) and not on the derivative in which it is used. The lack of measurability due to non-good business days that I described in several documents, including my Quant Perspective, will apply. It is certain that the "compounding setting in arrears" is not achievable.
As I'm at the non-good business day issue, I should mention a USD-LIBOR/SOFR specific issue. The holiday calendar of SOFR (USGS) is not the same as the one for LIBOR (USNY). As described in my "Fallback Transformers" series (a 8 episodes series starting here), this means that an (arbitrary) decision has to be taken on the adjustment of the compounding period. In my production code to analyze large portfolios under fallback scenarios, I have used a "following" rule as this is the standard approach for ON rates. This add to the lack of measurability issue, i.e. the actual rate to be used may be known only two (business) days after its related payment is due.
(1) G. Broyd and D. Wagner. Treliant Industry Insights June, 2019
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