FSB letter to ISDA regarding derivative contract robustness

The Financial Stability Board (FSB) has send a letter to ISDA about "derivative contract robustness to risks of interest rate benchmark discontinuation. The letter is public and available on the website of the FSB: http://www.fsb.org/2019/03/fsb-letter-to-isda-about-derivative-contract-robustness-to-risks-of-interest-rate-benchmark-discontinuation/

I would like to point to a couple of extracts of the letter than corroborate elements than I have mentioned in previous post. Those elements concern the process that lead to the changes in the fallback definition, and in particular those who have a value transfer impact.
In this regard, we encourage ISDA to consult [...] on the key technical details that ISDA’s Board Benchmark Committee will need to decide on before implementation can begin (including the parametrisation of the historical mean/median look-back, and the details of how the credit spread will be calculated and applied over the compounded rate).
The importance of this work is such that a careful process of assessment and consideration is essential before the publication of outcomes. [...] It is equally important to ensure transparency around how ISDA’s Board and/or Benchmark Committee would arrive at its decision.
The consultations from ISDA (and other working groups pursuing similar objective regarding benchmark transition) asked several questions with large range of possible answers. Certainly all the market participants answering those questions have their preferred solution in mind. On the other side, the groups in charge in reviewing the answers have only the answers at disposal, not the mind of the participants. It is essential for transparency that the exact way that the answer will be interpreted are described at the same time as the consultation. Some of the natural questions that need to be answered are:
  • Are the consultation results binding for ISDA? 
  • What if one of the option proposed is not achievable? This appear to be the case. What is done with the results? Should a full consultation be done again? 
  • When a question has a range of answers, how are the answers ranked? For example the spread computation "historical mean/median" has choice between mean and median, choice of the length of the historical period and choice on the transition period. Are all those choice votes for the same option or each alternative a separate option.
  • How are the results interpreted? The approach that has the most votes? Should an ordered of preference be ask for all non yes/no questions? Is there a weight by the importance of the participants? How would their importance be measured, with their weight in the derivative market, the size of their balance sheet, their quantitative finance expertise?

The Board also indicates the importance of transparency. In particular I believe it is important to indicate in advance how is the decisions will be communicated to the market. ISDA's Board and Benchmark Committee members are also in large part staff members in financial institutions trading IBOR derivatives. How is the potential conflict of interest between ISDA decisions and their impacts on institutions remunerating those members managed?

As described in different posts, the decisions can have a significant impact on the market and transferring value between market participants. Those transfers have already started and will continue which each decision. Certainly all those senior officers are looking in details at the impact of the LIBOR fallback and transition in their respective institutions. This is their duty and they certainly perform it diligently. This means that when they meet at ISDA for the decisions related to benchmarks, they know the impact of those decisions have on their institution's P/L and potentially on their own salary/bonus. How is that inherent conflict of interest managed? I guess that was the question behind the "important to ensure transparency around how ISDA[...] would arrive at its decision" sentence in the FSB's letter. When the decision has been taken but is not yet public knowledge, they board and committee members have an insider information. Beyond the decision making process transparency requested by FSB, it would be of interest also to request the transparency on the decision making timing. As suggested in a previous note, I recommend to have the decision made on a Saturday (outside market open hours) and publicly announced immediately (press release and detailed document publish on the website). In that way the interested market participants can be prepared at the opening of the markets on the next Monday.

Comments

Post a Comment

Popular posts from this blog

Multi-curve framework book: new edition in progress

Image
Subject: Interest Rate Modelling in the Multi-curve Framework: Foundations, Evolution, and Implementation It has been more than 10 years since I wrote the first edition of the multi-curve framework book. What happened in those 10 years? Why did it take me so long to start a new version? It took me roughly 10 years to write the first edition. The reason it took so long at that time, was that I did not know that I was writing it! I thought I was writing a couple of pages on an obscured and theoretical idea that there was not a `` one curve to rule them all '' but multiple curves. It turned out that it became the actual practice for very clear and important reasons. That was the excuse for the first edition, what is the excuse for the second edition? Since the first edition, many things happen, in particular: March 2015: BCBS - IOSCO: margin requirements for non-centrally cleared derivatives and mandatory variation margin July 2017: The future of LIBOR -- actually it...
Read more

Rigged: part 1 - Will there be a part 2?

Image
I have been reading book “Rigged: The Incredible True Story of the Whistleblowers Jailed after Exposing the Rotten Heart of the Financial” (Andy Verity, Flint, June 2023) for some time. It was published several month ago, but I just finished it. To my defence, I have to say that I don’t feel comfortable reading fiction where the “bad guys” are systematically winning by cheating. The book is the story of the miscarriage of justice done in the LIBOR manipulation story. The book content did not surprise me. For anybody having worked on a (swap) trading desk, it is clear that what was described by the accusation was impossible. It is not possible for some middle level trader to create a multi-year, multi-desk, multi-bank international conspiracy over open lines, broker lines, on open offices etc. without all around them, including compliance and senior management to be fully aware of what is going on. Moreover the regulators cannot be ignorant of the situation, except pleading complete in...
Read more

Treasury / Swap spreads are negative. And what?

In recent weeks there were several news articles related to the negative treasury/Swap spread. This is in particular the case of a Bloomberg article and a Zero Hedge blog . Some of the “information” in those notes are Swap rates are what companies, investors and traders pay to exchange fixed interest payments for floating ones. That rate falling below Treasury yields […]  is illogical in the eyes of most market observers, because it theoretically signals that traders view the credit of banks as superior to that of the U.S. government. It’s hard to overstate how illogical it is when swap spreads are inverted. That’s because it suggests that governments are less creditworthy than the very financial institutions they bailed out during the credit crisis just seven years ago. Let’s be clear, to me, those claims are purely wrong , nothing is “ illogical ” in negative swap spread. But why do I rant about that in the “multi-curve framework” blog? Because it is exactly the same that ...
Read more