The Brattle Group report on ISDA consultation: manipulation, false claims and lack of attribution.

I finally found the answers to the second ISDA consultation on IBOR fallback. It has been published on 19 September, but somehow you have to navigate through a layer of webpages to find it. It never appeared on the ISDA news. To my knowledge, the only link is on the last line of the announce of the consultation on final parameters. The direct link is https://www.isda.org/a/0LPTE/2019.09.18-Anonymized-ISDA-Supplemental-Consultation-Report.pdf

The report contains manipulation of the results, false claims, violate standard academic copyright fair use by not attributing to the authors in a recognizable way.

Manipulation

21. If the respondents’ ranking preferences to the 2018 Consultation were such that the compounded setting in arrears rate with historical mean/median approach was not the preferred combination (i.e., ranked second or lower), these respondents also were treated as answering “Yes” to Question No. 1 of the 2019 Supplemental Consultation as long as the respondents were not explicitly opposed to this combination in their response to the 2018 Consultation.

So even if you don't explicitly answer yes to the question to which they need you to do so, you will be considered to have answered yes!

False claims

25. advantages of the compounded setting in arrears rate with historical mean/median approach [...] include: present-value neutrality; [...] minimizing market manipulation;

Both "present-value neutrality" and "minimizing market manipulation" are clearly false. To the extend that in paragraph 29, the report says "the historical mean/median approach may not be present-value neutral." The historical approach leave the door open to manipulation. It may provide less opportunity to manipulation than other methods, but it certainly does not "minimize" anything. For example, selecting a purely random process to decide of the spread would be less prone to manipulation.

No attribution

The report quote from answers but does not attribute explicitly to the authors. By doing so, the report reduce the commercial value of the answers; it deprives the authors of the though leadership advantage of their answers. By reproducing the most important parts of the answers, it induce less people to read the full answers. It create a competition to the original answers.

My original document was very explicit on this point: "Copyright (c) by Marc Henrard. No quotation of this document is allowed without properly identifying the source and the author."

I have found at least three quotes from my answer. It appears that I'm the only respondent from Belgium and the only professional services firm from Europe. I was gratified by those lengthy quotes.

30. In addition, a European professional services firm commented, “The historical mean/median approach is appropriate under the condition that a strong governance procedures...are in place. For the moment, this appears not to be the case. Note that historical rate approach has created value transfer and will still do so in the future.”

48. A European professional services firm further emphasized, “The use of past data, by opposition to data that would neutralise the value transfers, is already a substitute to a neutral spread. The use of a substitute to the substitute is not changing fundamentally the issue. Like for other answers related to the spread, one will have to make sure that the governance related to that choice, as for example described in Section 1.6, is strictly enforced. One way to reduce the material non-public information issue would be to use some random selection of data...”

64. European professional services firm, which stated that “this is not a good choice. It leaves the SGD market dependent on choices that may not be relevant for its market. We strongly recommend to have a term rate fallback adapted to the local market. Rate like SIBOR already exists and could be used as one of the steps in a waterfall implementation of the fallback.”

Missing the point

Obviously, the "summary" is missing the main point that the compounding setting in arrears is not achievable. Indicating that explicitly in the answer summary would undermine their claim that "all is well in a perfect world".

But at the same time, the publication of the consultation on the same day called "Consultation on Final Parameters for the Spread and Term Adjustments in Derivatives Fallbacks for Key IBORs" is the proof that there is a major issue with their previous consultations.

First the name contains "term adjustments". This refers to the "The compounded setting in arrears rate approach" which is defined by "The fallback could be to the relevant RFR observed over the relevant IBOR tenor and compounded daily during that period." Yes the main item of the definition, the "IBOR tenor", is now subject to adjustments! Most of the questions in the new consultation are about workarounds related to that initial definition which is not achievable as such. It has been my thesis for more than 18 months. Instead of reviewing the issue globally, a non-achievable solution has been pushed through and now workarounds that are destroying the advantages of the method but leaving most of the disadvantages are discreetly introduced! A dirty job to my opinion. To the point that at this stage, I would advise my clients not to sign the protocol if those definitions are imposed on the market.

Fallback of the fallback

Note that each pair of counterparties does anyway need to bilaterally agree a separate fallback for the instruments that do not fit the narrow ISDA definition. To quote a North American bank/broker-dealer: “We believe that it is not clear that the fallbacks that ISDA has proposed in this consultation would work for any products other than vanilla interest rate swaps.” Personally, I go one step further by saying it will not work for many vanilla swaps either. But the main point is, even if related to a unique pay-off, you still have to bilaterally re-paper your agreement with each counterparty individually, you need a fallback to the ISDA official fallback. And ISDA has already said that they will not help you with that. Why bother with a protocol which has an unknown financial impact for you if it does not solve your main problem?

BMR compliant?

Also, it is not clear to me that the "historical approach" is acceptable under the EU Benchmark regulation. I'm not the only to have those doubts: a North American bank/broker-dealer raised a different issue regarding “permissibility”: “[This North American bank/broker-dealer] believes that it would be appropriate to use this indicative data, so far as it is permissible for use, when calculating “adjusted SOFR,” under relevant law(s) and/or regulation(s)." I will write some email to ESMA about the compliance with the BMR in the context of the transition. I will let you know if I get any answer.