American option on protocol signature

The UK government and the FCA have announced their intention to enhance the FCA powers in relation to benchmarks. Those powers would allow the FCA to artificially extend the shelf live of LIBOR for tough legacy contracts. This is really an announcement about "The future of LIBOR" while the 2017 announcement by A. Baily should have been called "The lack of future of LIBOR".

Extending the life of LIBOR means increasing the difference between the legacy ISDA LIBOR definitions (and other LIBOR definitions) and the new ISDA LIBOR definitions. This is really the goal of this proposal targeting "tough legacy". This enhanced power by regulators enhanced the difference between legacy and new definition and thus enhanced the valuation difference between contracts subject to the different fallback procedures. This statement on regulatory powers should be complemented by a statement on caution. The effects that I described in my Risk.net column Signing the LIBOR Fallback protocol: a cautionary tale are increased. Less and less, the protocol signature can be considered as a "fair" treatment. The implied value transfers are increasing. A new strategy will emerge: not doing anything about legacy LIBOR contracts for part of the "wind-down period" for tough legacy and decide on signing the protocol or not during that period. The FCA proposal is changing the protocol signature European option feature (sign or not a cessation) into a signature American option (decide to sign or not in a given period).

This transition is really becoming fun. More the laymen try to solve the problem, more the experts will have options to make money.

I would like to take the occasion of this column to thank ISDA and FCA for providing so much material for future quant work.

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