Libor transition plans: delaying CCP discounting big-bang?
At a Quant Summit's panel last week, I was asked about the impact of
Corona virus on LIBOR transition. Some of my comments were reported in
Risk in the article Pandemic threatens Libor transition plans.
I'm not a medical doctor (merely a doctor in mathematics) and I have no relevant advice on the pandemic itself. But if there are events that require special efforts and staff involvement (and the current situation certainly fit this description), is there some planned changes in the market that could be delayed? My immediate answer at the panel was UMR category 5 and LIBOR cessation.
UMR is a long term project; the exact date is not important, what is important is the long term impact in term of counterparty risk in derivative; the approach selected can be agreed with or not, but certainly the impact is long term. The preparation impact is huge, but the financial impact on the implementation date will be 0. Delaying its start date by some months, or at least delaying the control of all the regulatory details, does not change the general impact on the market. The exact timing is not critical. It is not an all-or-nothing mechanism, it is a gradual impact on new trades only.
The LIBOR discontinuation is different. LIBOR will be discontinued once; it may require a long term preparation, there may be long term benefits to use a different benchmark (or not) but the discontinuation itself is of no benefit to anybody.
What I did not mention in my answer, but I would like to add after thinking a little bit more about it, is the CCP big bang collateral/discounting changes. This is planned for June (EUR) and October (USD). This issue is closer to us in the financial market calendar. Moreover there is no urgency or necessity to have it now; we could delay it for at least 18 month in EUR and indefinitely in USD. Even the EUR deadline is artificial and could be postponed by another year or two by a simple decision of regulators and EMMI (just continue to publish EONIA at ESTR + 8.5 bps for an extra year or two). The discounting big-bang has a small impact on CCPs, their internal systems have just to switch one curve, they have one week-end to compute 2 MTM and their difference for cash compensation purposes. The impact on users is more serious. They will have to develop full risk management tools in parallel for the two rates and they will face a market fragmentation (cleared v non-cleared). They cannot switch curves, they have to work with two sets in parallel as long as the full market has not transitioned; this could take several years.
Moreover there are also the indirect impacts of the big bang. The most visible of them being the question about swaptions delivery, but it also includes forward clearing and any mechanism that refers to a clearing action or figure but is not immediate clearing. Personally, I propose to postpone big-bang sine die. My preferred solution is the one described in step 4 and 5 of the original ARRC paced transition plan, including the option for users to chose the collateral in the existing or the new rate at least for a certain period of time, e.g. one year. Once the big-bang is postpone, end user will be able to focus on more urgent and important matter, as their personal health and their business economical health. On the financial side, the issues created by the forced big-bang can now be solved properly. For example in the swaptions contract, one can explicitly indicate the discounting mechanism. That is not a problem anymore as only one of them exists (the current EONIA or Fed Fund). The contract can also include the mechanism if the CCPs unilaterally change the collateral. When the economical and health situation is stabilised, we can start the transition project again, based on the planned paced transition, clarify the list of issues related to the transition and propose well-conceived solutions for all of them before creating a new time table for the said collateral transition.
Note added 2020-03-21: It seems that the European Commission does not share my opinion. There was a message from EC stating that the commission has no intention of postponing UMR phase 5 because ... "They can be expected to be adopted by the European Commission shortly" (see Risk.Net article EC: No plans to delay IM phase five) and that cannot be changed. Moreover the CFTC announcing, as a publicity stunt, the UMR phase 6 decided many month ago as a "regulator’s response to Covid-19" are not helping.
Note added 2020-03-26: For once, it seems that ISDA is sharing my opinion. They, with other associations, have sent a letter to the BCBS to consider delaying UMR phase 5 and 6 sine die. I hope they will also sent a similar letter to CCP regarding discounting big bang.
Note added 2020-03-30: The question of a CCP big bang discounting delay is now openly discuss in the market. Risk.Net published an article titled Virus turmoil threatens swaps discounting switch (subscription required) about it today. LCH obviously commenting that "for the moment that date remains". For the CCP the switch is simply replacing one curve by another over a week-end. For the users it is having two full systems in parallel. If I could choose, I would go the initial ARRC paced transition plan and offer the option to the users. That would require flexibility from the CCP side; they prefer to require the flexibility from all the end-users. An intermediate possibility would be to have a "not so big" bang; switch from EONIA to ESTR+8.5bps for collateral. That means no valuation change with the advantage of removing the legal pressure to switch before the deadline of December 2021. With that, at least the transition is acted and we delay the heavy lifting in term of risk management for the end-users for a better time.
I'm not a medical doctor (merely a doctor in mathematics) and I have no relevant advice on the pandemic itself. But if there are events that require special efforts and staff involvement (and the current situation certainly fit this description), is there some planned changes in the market that could be delayed? My immediate answer at the panel was UMR category 5 and LIBOR cessation.
UMR is a long term project; the exact date is not important, what is important is the long term impact in term of counterparty risk in derivative; the approach selected can be agreed with or not, but certainly the impact is long term. The preparation impact is huge, but the financial impact on the implementation date will be 0. Delaying its start date by some months, or at least delaying the control of all the regulatory details, does not change the general impact on the market. The exact timing is not critical. It is not an all-or-nothing mechanism, it is a gradual impact on new trades only.
The LIBOR discontinuation is different. LIBOR will be discontinued once; it may require a long term preparation, there may be long term benefits to use a different benchmark (or not) but the discontinuation itself is of no benefit to anybody.
What I did not mention in my answer, but I would like to add after thinking a little bit more about it, is the CCP big bang collateral/discounting changes. This is planned for June (EUR) and October (USD). This issue is closer to us in the financial market calendar. Moreover there is no urgency or necessity to have it now; we could delay it for at least 18 month in EUR and indefinitely in USD. Even the EUR deadline is artificial and could be postponed by another year or two by a simple decision of regulators and EMMI (just continue to publish EONIA at ESTR + 8.5 bps for an extra year or two). The discounting big-bang has a small impact on CCPs, their internal systems have just to switch one curve, they have one week-end to compute 2 MTM and their difference for cash compensation purposes. The impact on users is more serious. They will have to develop full risk management tools in parallel for the two rates and they will face a market fragmentation (cleared v non-cleared). They cannot switch curves, they have to work with two sets in parallel as long as the full market has not transitioned; this could take several years.
Moreover there are also the indirect impacts of the big bang. The most visible of them being the question about swaptions delivery, but it also includes forward clearing and any mechanism that refers to a clearing action or figure but is not immediate clearing. Personally, I propose to postpone big-bang sine die. My preferred solution is the one described in step 4 and 5 of the original ARRC paced transition plan, including the option for users to chose the collateral in the existing or the new rate at least for a certain period of time, e.g. one year. Once the big-bang is postpone, end user will be able to focus on more urgent and important matter, as their personal health and their business economical health. On the financial side, the issues created by the forced big-bang can now be solved properly. For example in the swaptions contract, one can explicitly indicate the discounting mechanism. That is not a problem anymore as only one of them exists (the current EONIA or Fed Fund). The contract can also include the mechanism if the CCPs unilaterally change the collateral. When the economical and health situation is stabilised, we can start the transition project again, based on the planned paced transition, clarify the list of issues related to the transition and propose well-conceived solutions for all of them before creating a new time table for the said collateral transition.
Note added 2020-03-21: It seems that the European Commission does not share my opinion. There was a message from EC stating that the commission has no intention of postponing UMR phase 5 because ... "They can be expected to be adopted by the European Commission shortly" (see Risk.Net article EC: No plans to delay IM phase five) and that cannot be changed. Moreover the CFTC announcing, as a publicity stunt, the UMR phase 6 decided many month ago as a "regulator’s response to Covid-19" are not helping.
Note added 2020-03-26: For once, it seems that ISDA is sharing my opinion. They, with other associations, have sent a letter to the BCBS to consider delaying UMR phase 5 and 6 sine die. I hope they will also sent a similar letter to CCP regarding discounting big bang.
Note added 2020-03-30: The question of a CCP big bang discounting delay is now openly discuss in the market. Risk.Net published an article titled Virus turmoil threatens swaps discounting switch (subscription required) about it today. LCH obviously commenting that "for the moment that date remains". For the CCP the switch is simply replacing one curve by another over a week-end. For the users it is having two full systems in parallel. If I could choose, I would go the initial ARRC paced transition plan and offer the option to the users. That would require flexibility from the CCP side; they prefer to require the flexibility from all the end-users. An intermediate possibility would be to have a "not so big" bang; switch from EONIA to ESTR+8.5bps for collateral. That means no valuation change with the advantage of removing the legal pressure to switch before the deadline of December 2021. With that, at least the transition is acted and we delay the heavy lifting in term of risk management for the end-users for a better time.
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