CCP LIBOR cessation big bang: what about swaptions?

Over the last months there have been many discussion about the fallback (or more precisely the absence thereof) of cleared LIBOR swaps. The CCPs are planning another "big bang". Having been interested by astronomy since I was young, I thought there is only one "Big Bang" possible, but I'm not an expert. Maybe we should rename the LIBOR transition "bangs" as SME (Small and Medium-size Explosions).

This new SME would cancel all existing LIBOR swaps before the cessation of LIBOR and create OISs with slightly modified payment dates. The solution is certainly one that I'm in favor of, having push for it by opposition to the ISDA Frankenstein-like fallback. I have suggested to my clients for many month to do something similar (see here and here). The ISDA fallback is unmanageable from a market risk perspective as described in previous blogs: Fallback transformers: gaps and overlaps and here. Probably those public analysis have been used by CCPs to consider their options.

My questions in this post are not about the proposition itself but by the lack of consideration for the market in general. What is happening to mandatory clearing? What will happen to the swaptions?

To the best of my knowledge the mandatory clearing obligations for LIBOR swaps are still in place. What is happening if a swap is traded, it is under mandatory clearing obligations and there is no clearing house that accepts it? What happen if a swaption is exercised with physical cleared swap delivery and there is no CCP accepting such a swap? What happen to a swap for which there is an agreement between the parties to clear at a forward date and the CCP does not clear that swap anymore at that forward date?

The recent document by CME related to the LIBOR swap SME proposes 3 alternatives. The two that are not a direct ISDA fallback application indicates explicitly "Inability to clear legacy bilateral swaption expiries". The LCH proposal does not provide any indication about this issue, but given historical behavior, we can guess they don't care. What would happen to those swaptions? An extra tailor made bilateral agreement would be required between each pair of counterparties, to deal with one more issue not taken into consideration by ISDA and the CCPs? Would the trade be considered "frustrated" as the object of the delivery (a cleared LIBOR swap) does not exist anymore?

I'm looking forward to see how those issues, that have been known to quants looking at the details of interest rate trading for several years, will be "discovered" by the market.

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