Fallbacks consultations: No clash in the answers; clash in questions!
The results of the ECB-led consultation on term-rates for the EURIBOR fallback have been published. There were no surprise with the results, they were in line with the working group analysis. The most trusted version of the overnight derivative based term rate is the OIS quote version and the majority of the respondent believe that such a term-rate benchmark is not only feasible, but "essential" or "desirable".
This results may be seen as in opposition to the results of the ISDA consultation on IBOR fallback where a compounding setting in arrears was selected. To my opinion, there is no clash in the answers, only clash in the questions!
The ISDA questions were, even if not explicit in the questions but implicit in the document, conditional to ignoring the main drawback of the option that was selected by the majority and conditional to proposing a limited selection of options, in particular excluding one of the natural approaches that was the subject of the ECB-lead consultation. The ISDA consultation question was: conditional to those constraints, what is you preferred choice?
On the other side, the Euro-working group questions were conditional to the fallback choice being a RFR derivative-based term rate. Conditional to those constraints, what is you preferred choice?
In regards to the questions, none of the two consultations were anything like a democracy of the market (or even a plutocracy), it is a dictatorship of those who asked the questions. Some questions were asked with several gradation in the answers. There was no clear a priori description of how the answer would be analyzed. For example would one answer indicating (and proving) that one solution was not achievable be enough to disqualify that proposal from being selected? The answer to that appears to be no, it is possible to select an unachievable approach. In a real democracy, not only all can vote, but also all can propose themselves for election and be elected. In this case, the options/approaches in the consultation should also have been consulted and each participant to the consultation should have been able to propose an option to be included in the consultation.
The fragmentation of the consultation questions can be paralleled to the market and regulation fragmentation. From a user perspective, it seems that there is no global perspective, but "local" questions that make the life of those asking the questions easy but not solving the global issues. This fragmentation can already be seen in the RFR selection with some secured (SOFR, SARON) and some unsecured (ESTER, SONIA, TONA) and with regulation conflicting between jurisdictions.
One obvious fragmentation, that could be called the elephant in the room, is the difference between fallbacks that are achievable and those that are not. The ISDA proposal is currently not achievable because the existing term sheets of some (the majority) of the traded instruments do not allow it. There is, to the best of my knowledge, no current proposal to change the term sheets of those instruments.
The EUR working group solution is currently not achievable because the target new benchmark (OIS term benchmark) does not exist. But at least there is a plan to create such a benchmark when the market liquidity will allow it.
Hopefully the two streams will join at some stage and the ISDA will review its fallback options and include the logical RFR term rate, probably only in a multi-level waterfall fallback, and an achievable temporary other fallback if the OIS benchmark did not exist yet on discontinuation. Also a fallback to a term rate does not prevent they users to switch bilaterally to "compounding in arrears" for the (few?) derivatives for which this is achievable. That would be some type of optional waterfall step.
The clash between the different consultations is described in a Risk.Net article titled "Swaps market heading for Libor fallbacks clash".
This results may be seen as in opposition to the results of the ISDA consultation on IBOR fallback where a compounding setting in arrears was selected. To my opinion, there is no clash in the answers, only clash in the questions!
The ISDA questions were, even if not explicit in the questions but implicit in the document, conditional to ignoring the main drawback of the option that was selected by the majority and conditional to proposing a limited selection of options, in particular excluding one of the natural approaches that was the subject of the ECB-lead consultation. The ISDA consultation question was: conditional to those constraints, what is you preferred choice?
On the other side, the Euro-working group questions were conditional to the fallback choice being a RFR derivative-based term rate. Conditional to those constraints, what is you preferred choice?
In regards to the questions, none of the two consultations were anything like a democracy of the market (or even a plutocracy), it is a dictatorship of those who asked the questions. Some questions were asked with several gradation in the answers. There was no clear a priori description of how the answer would be analyzed. For example would one answer indicating (and proving) that one solution was not achievable be enough to disqualify that proposal from being selected? The answer to that appears to be no, it is possible to select an unachievable approach. In a real democracy, not only all can vote, but also all can propose themselves for election and be elected. In this case, the options/approaches in the consultation should also have been consulted and each participant to the consultation should have been able to propose an option to be included in the consultation.
The fragmentation of the consultation questions can be paralleled to the market and regulation fragmentation. From a user perspective, it seems that there is no global perspective, but "local" questions that make the life of those asking the questions easy but not solving the global issues. This fragmentation can already be seen in the RFR selection with some secured (SOFR, SARON) and some unsecured (ESTER, SONIA, TONA) and with regulation conflicting between jurisdictions.
One obvious fragmentation, that could be called the elephant in the room, is the difference between fallbacks that are achievable and those that are not. The ISDA proposal is currently not achievable because the existing term sheets of some (the majority) of the traded instruments do not allow it. There is, to the best of my knowledge, no current proposal to change the term sheets of those instruments.
The EUR working group solution is currently not achievable because the target new benchmark (OIS term benchmark) does not exist. But at least there is a plan to create such a benchmark when the market liquidity will allow it.
Hopefully the two streams will join at some stage and the ISDA will review its fallback options and include the logical RFR term rate, probably only in a multi-level waterfall fallback, and an achievable temporary other fallback if the OIS benchmark did not exist yet on discontinuation. Also a fallback to a term rate does not prevent they users to switch bilaterally to "compounding in arrears" for the (few?) derivatives for which this is achievable. That would be some type of optional waterfall step.
The clash between the different consultations is described in a Risk.Net article titled "Swaps market heading for Libor fallbacks clash".
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