2019-04-23

SFIG answer to ARRC: we recommend ... forward-looking term SOFR

Published a couple of months ago, but I had not seen it before: SFIG answer to ARRC Consultation -New Issuances of LIBOR Securitization.

In the answer to Question 5(a) is this paragraph:
SFIG believes that for the launch of SOFR as a replacement benchmark for LIBOR to realize its highest potential for universal acceptance, it is essential for ARRC to move forward with its paced transition plan culminating in the development forward-lookingterm SOFR. We, therefore, recommend that the primary fallback for securities referencing LIBOR be forward-looking term SOFR selected, endorsed or recommended as the replacement for LIBOR by the Federal Reserve Board and/or the NY Fed, or by the ARRC. 
I would write the same for derivatives: I recommend that the primary fallback for derivatives referencing LIBOR be forward-looking term SOFR.

ICE Swap Rate fallback?

The ICE Swap Rate (formerly ISDAFIX) is a (forward looking) benchmark based in LIBOR-linked swaps synthetic order books. The benchmark is used in CMS-like products and in cash-settled swaptions (EUR, GBP).

As their underlying swaps are LIBOR-linked, they will stop to be quoted when LIBOR is discontinued.

There is a lot of work done around the LIBOR fallback. I have not heard anything about the planned fallback for those benchmarks. Is there a working group looking at this issue? At ISDA or ARCC/Euro risk-free rate working group level? Don't hesitate to leave details/links about this in the comments.

2019-04-02

Where quarterly rate's spikes are discussed again!

Why trying to introduce a complex cure for a symptom when there is a simple cure for the disease? This is the question I was asking myself when reading about the Fed and SOFR (repo rate) month-end spikes. The month-end spikes are not a natural economical cycles. They are artificial ones created by the regulators. Balance sheets, liquidity ratios and some other regulatory figures are measured on a monthly or quarterly basis. The quarter ends are becoming important dates for banks. As banks are an important cog in the economy, quarter ends are becoming important for the economy.

As a reaction to the (repo) liquidity drying at quarter end, the Fed is proposing some special repo facility to decrease the rate spikes symptoms. But these spikes are totally artificial constructions. Why are the balance sheets still measured only on quarters end only. Nowadays everything in banking seems to be real time and online, from retail payments to complex risk figures like VAR, XVA and IM. Why are balance sheet only measured quarterly? See a previous rant about this at the end of this blog. If regulators are serious about systemic risk in financial markets, why are they looking at it only one day each quarter? Would it be impossible for a bank to get into trouble in one of 59 business days of the quarter where those numbers are not looked at by regulator? When did Lehman bankrupt? Was it at month-end?

The Fed are not the only regulators of banks in the US, nevertheless the Fed’s risk-based capital surcharge may have an impact on the quarter end spikes. The Fed's repo facility proposal sound to me like road designers proposing to add some rubber in the road material just after the speed-bump they have installed on a new high-way to reduce the damage on cars from the speed bumps.



This is the visible impact on liquidity of the discrete measurement of regulatory figures, but those one-day measurements also have (less visible) impacts on risk management. Some financial institutions ask their traders to reduce their risk management activities over quarter ends as it is costly from a regulatory point of view. Is the goal of G-Sib and similar figures to reduce liquidity and risk management activities in financial institutions? If not their design should be fundamentally reviewed.


2019-04-01

LIBOR fallback and term sheets

Ever since the publication of the ISDA consultation related to IBOR fallback, I have claimed that the approach that ended to be selected, the compounded setting in arrears, was ill-defined and a bad choice for many instruments.

My favorite example was the FRA. I choose the FRA because it is a simple liquid instrument where the flaws of the proposal are obvious. Following my notes and seminars on the subject, the market has also noticed the problem. Several articles have been published on the subject in Risk.Net and different market participants have commented on it. If this awareness of the problem by market participants is a good thing, the absence of ISDA comments is worrisome.

There are discussion to change the FRAs standard term sheet or to transition to single period swaps instead of FRA. That solution, which was among the possibilities that I mentioned in the past (see for example this blog), is worth discussing. Nevertheless, the solution proposed seems at the moment attacking an obvious symptom of the disease, not the disease itself. The disease, to my opinion, is to replace a term rate by a non-term rate. The term sheet change proposal refers only to FRAs, not to others like LIBOR in-arrears. Even the FRAs and plain vanilla swaps are not fully solved. Due to non-good business days, the solution (which still lack details) will fall short by one day in many cases (roughly 2 coupons out of 7).

It is good to have those discussions. The best approach would be to bring a couple of willing and knowledgeable people around a table and write workable detailed proposals with all the pros and cons of each option. The details should include at the very least precise formulas with precise dates schedules (fixing, payment, accrual, etc.). Such a proposal should not take more than a couple of days to devise (or to be shown impossible to devise). I'm volunteering to act as an independent advisor if such a working group is created. Any other quant or association ready to join?