Compounded rate out of favour: what now?
This morning I was reading the article in Risk.Net titled Compounded rate out of favour, finds Japan survey published yesterday.
My reaction was: I have heard that before, what now?
Let me explain this with a little bit more details. For this I need to quote a couple of sentences from the article that are part of the "I have heard that before":
The article then indicates:
This is taking the problem the wrong way. The questions should be: "What do the end user want?" and "How can be banking system best accommodate those requirements?"
There is no reason to shoe-horn a solution that end users don't want, don't understand and which does not fulfill their requirements just to fit the personal belief of regulators that some approach to financial markets is better than another.
End users prefer term rates, how can the financial market satisfy this preference at best? That should be the only question asked. Derogatory comments by "dealers" about "lack of familiarity" and "ignorance" are not the way forward (pun intended). I would even say that such statements only proves the "ignorance" by the "dealers" of what a derivative dealer in financial market should be: a person who offers derivative adapted to the risk management needs of the end users.
The question that regulators and banking associations have to ask is: What now? Regulators and ISDA (influenced by the regulators, according to people privy of the discussions who prefer to stay anonymous) have been "all-in" for compounded in arrears for several years now. There is more and more reluctance by end users to move in that direction for everything. And the reluctance reasons are clear. What are the regulators and ISDA proposing now? There is no lack of proposals to help them with different approaches more in line with end users requirements. The first step is to acknowledge the problem and to review the available solutions. We don't need to start from scratch; many people and institutions have worked on the problem over the past years. But we need to take a clean sheet and decide what to put on it, based on end user requirements, without the ego of previous deciders hindering.
My reaction was: I have heard that before, what now?
Let me explain this with a little bit more details. For this I need to quote a couple of sentences from the article that are part of the "I have heard that before":
A majority of market participants in Japan want to use forward-looking term rates instead of compounded risk-free rates as a reference for new loans and floating rate notes.Similar findings had been obtain for EUR fallback (including derivatives) when the forward-looking term rates were included in the option list.
The article then indicates:
The preference for forward-looking rates, two dealers say, is due to a lack of familiarity with Japan’s designated risk-free rate, Tonar, coupled with an ignorance of the challenges in developing a robust forward-looking benchmark.
This is taking the problem the wrong way. The questions should be: "What do the end user want?" and "How can be banking system best accommodate those requirements?"
There is no reason to shoe-horn a solution that end users don't want, don't understand and which does not fulfill their requirements just to fit the personal belief of regulators that some approach to financial markets is better than another.
End users prefer term rates, how can the financial market satisfy this preference at best? That should be the only question asked. Derogatory comments by "dealers" about "lack of familiarity" and "ignorance" are not the way forward (pun intended). I would even say that such statements only proves the "ignorance" by the "dealers" of what a derivative dealer in financial market should be: a person who offers derivative adapted to the risk management needs of the end users.
The question that regulators and banking associations have to ask is: What now? Regulators and ISDA (influenced by the regulators, according to people privy of the discussions who prefer to stay anonymous) have been "all-in" for compounded in arrears for several years now. There is more and more reluctance by end users to move in that direction for everything. And the reluctance reasons are clear. What are the regulators and ISDA proposing now? There is no lack of proposals to help them with different approaches more in line with end users requirements. The first step is to acknowledge the problem and to review the available solutions. We don't need to start from scratch; many people and institutions have worked on the problem over the past years. But we need to take a clean sheet and decide what to put on it, based on end user requirements, without the ego of previous deciders hindering.
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