LIBOR fallback parameters: my biased reading of the biases.
I'm preparing my answer to the ``Consultation on Final Parameters for the Spread and Term Adjustments in Derivatives Fallbacks for Key IBORs'' issued by ISDA.
By reading the questions at the end of the consultation, I have the impression they have at last read my July 2018 and January 2019``quant perspective'' (available on SSRN here and here). A lot of the questions asked in the consultation were debated there: negative "spreads" (monetary policy misestimation), proposal not achievable and requiring shifts or lockouts, holiday calendar problems, shift and lockout workaround not working, calculation period instead of IBOR period. Maybe I should start my answer with "I told you".
Even if my fingers are itching, I will make an extensive effort and answer the consultation in a business-like fashion in my official answer. But in my blog, I can let my fingers fly and make blog-like answers!
Q: Which cities should apply for the purposes of the two-Banking Day backward-shift or lockout?
A: What do you mean by ``cities'', I trade with business calendar. What is the "GS" city in USGS? What is the city "TA" in EUTA?
Q: Would either option be problematic or would you be able to transact if either option were implemented for derivatives fallbacks? Please explain.
A: The shift and lockout options are both problematic. We would not accept trading instruments that could switch from one rate relevant interest rate period to another (LIBOR period to shifted/lockout period) at the whim of a couple of people in an Ivory tower. We have the tools to value and risk manage many optional products, including exotics. This switch is not a financial option but a regulatory and legal option. Those options cannot be valued and hedged using the standard valuation mechanism based on replication. Under those options, the financial instruments traded would include a lottery ticket. Our main view of financial markets is to provide risk management tools for the economy, not to create lottery tickets. We do not transact in lottery tickets.
Q: Is it problematic to use the Calculation Period instead of the IBOR period?
A: What do you mean by that? I was told that "LIBOR means LIBOR"! Did someone lied to me? Would it be possible that two LIBORs legally equal today would not be equal tomorrow?
On this last note, the parallel between Brexit and fallback is more and more relevant. People have voted in consultations, also called referendum, to ill-formulated questions without a clear description of what each of them means. After the consultation, a couple of people interpret those answers to match their own interest and claim to have the "people" backing. When the actual implementation has to be done, the practical questions that have been asked by people that took the time to research the issues in depth come to the surface and are "discovered" by the "deciders". Long lists of dirty workarounds have to be invented. Some people are asked to vote on the workaround but not on the fundamental question that should have been asked at the start: do you want this option, including all its dirty workaround, or this other option, or do you want to propose a meaningful alternative. Obviously all the meaningful alternatives should have been analyzed and put on the second round of consultations; the first round of consultation has to be considered as indicative only. If none of the alternatives of the second consultation have an absolute majority, then we are stuck. There is no way to democratically eliminate any of the solutions. But nevertheless, we could check that all the options are achievable in practice and eliminate those which are not. The next step would be to have a "parliament" coming to a consensus choice. How to elect that parliament is a fundamental question that I will not address here (because I don't have a meaningful answer to it).
I would also suggest that fallback consultation's participants should state the sensitivity of the derivative book of the firm they represent to the adjustment spread. The sensitivity could be described as USD x,xxx,xxx for a spread increase of 1 basis point (bp). The answers to the consultation would then be weighted with a weighting scheme decreasing in the absolute value of the sensitivity. The conflicted answers should be weighted less. On the opposite side, a weighting scheme with weights increasing with the quantity and quality of published technical documents on the subject (not marketing documents) should be established. I know that those mechanisms would create a maximum bias for my answer; this is the goal. If you are surprised, read the post's title again. In general I would advise the readers to have at their disposal a good quantity of pinches of salt when reading my blogs.
Any answer to the consultation is a manipulation of the market. This is my first manipulation (see manipulation definition 1 in Oxford dictionary) attempt for this consultation. There will be more. I will publish my final answer as soon as it is ready.
By reading the questions at the end of the consultation, I have the impression they have at last read my July 2018 and January 2019``quant perspective'' (available on SSRN here and here). A lot of the questions asked in the consultation were debated there: negative "spreads" (monetary policy misestimation), proposal not achievable and requiring shifts or lockouts, holiday calendar problems, shift and lockout workaround not working, calculation period instead of IBOR period. Maybe I should start my answer with "I told you".
Even if my fingers are itching, I will make an extensive effort and answer the consultation in a business-like fashion in my official answer. But in my blog, I can let my fingers fly and make blog-like answers!
Q: Which cities should apply for the purposes of the two-Banking Day backward-shift or lockout?
A: What do you mean by ``cities'', I trade with business calendar. What is the "GS" city in USGS? What is the city "TA" in EUTA?
Q: Would either option be problematic or would you be able to transact if either option were implemented for derivatives fallbacks? Please explain.
A: The shift and lockout options are both problematic. We would not accept trading instruments that could switch from one rate relevant interest rate period to another (LIBOR period to shifted/lockout period) at the whim of a couple of people in an Ivory tower. We have the tools to value and risk manage many optional products, including exotics. This switch is not a financial option but a regulatory and legal option. Those options cannot be valued and hedged using the standard valuation mechanism based on replication. Under those options, the financial instruments traded would include a lottery ticket. Our main view of financial markets is to provide risk management tools for the economy, not to create lottery tickets. We do not transact in lottery tickets.
Q: Is it problematic to use the Calculation Period instead of the IBOR period?
A: What do you mean by that? I was told that "LIBOR means LIBOR"! Did someone lied to me? Would it be possible that two LIBORs legally equal today would not be equal tomorrow?
On this last note, the parallel between Brexit and fallback is more and more relevant. People have voted in consultations, also called referendum, to ill-formulated questions without a clear description of what each of them means. After the consultation, a couple of people interpret those answers to match their own interest and claim to have the "people" backing. When the actual implementation has to be done, the practical questions that have been asked by people that took the time to research the issues in depth come to the surface and are "discovered" by the "deciders". Long lists of dirty workarounds have to be invented. Some people are asked to vote on the workaround but not on the fundamental question that should have been asked at the start: do you want this option, including all its dirty workaround, or this other option, or do you want to propose a meaningful alternative. Obviously all the meaningful alternatives should have been analyzed and put on the second round of consultations; the first round of consultation has to be considered as indicative only. If none of the alternatives of the second consultation have an absolute majority, then we are stuck. There is no way to democratically eliminate any of the solutions. But nevertheless, we could check that all the options are achievable in practice and eliminate those which are not. The next step would be to have a "parliament" coming to a consensus choice. How to elect that parliament is a fundamental question that I will not address here (because I don't have a meaningful answer to it).
I would also suggest that fallback consultation's participants should state the sensitivity of the derivative book of the firm they represent to the adjustment spread. The sensitivity could be described as USD x,xxx,xxx for a spread increase of 1 basis point (bp). The answers to the consultation would then be weighted with a weighting scheme decreasing in the absolute value of the sensitivity. The conflicted answers should be weighted less. On the opposite side, a weighting scheme with weights increasing with the quantity and quality of published technical documents on the subject (not marketing documents) should be established. I know that those mechanisms would create a maximum bias for my answer; this is the goal. If you are surprised, read the post's title again. In general I would advise the readers to have at their disposal a good quantity of pinches of salt when reading my blogs.
Any answer to the consultation is a manipulation of the market. This is my first manipulation (see manipulation definition 1 in Oxford dictionary) attempt for this consultation. There will be more. I will publish my final answer as soon as it is ready.
Comments
Post a Comment