Open letter to Ursula VON DER LEYEN in relation to REGULATIONS on the designation of a statutory replacement for certain settings of CHF LIBOR

Open letter to Ursula VON DER LEYEN in relation to
REGULATIONS
COMMISSION IMPLEMENTING REGULATION (EU) 2021/1847
of 14 October 2021
on the designation of a statutory replacement for certain settings of CHF LIBOR

Dear Ursula,

I read with interest your REGULATION (EU) 2021/1847.

If you don't mind, I would have a couple of simple questions regarding the text. I'm certain the numerous consultations you indicate you have done have already answered those questions, so it should just take you a couple of minutes to answer them.

Ambiguous definitions (rate)

The text indicates

1-month CHF LIBOR is replaced by 1-month SARON compound Rate, as observed over the 1 month period preceding the interest period;

What is the meaning of "1 month period preceding". From my experience, this is not a trivial question in finance. The first ISDA consultation, published in July 2018, had a similar issue. It indicated "observed over the relevant IBOR tenor and compounded daily during that period". It took almost 2 years, up to the publication of Bloomberg's "IBOR Fallback Rate Adjustments Rule Book" to get a proper definition of that sentence. As early as July 2018, I had already indicated the issues behind those weak definitions in "A Quant Perspective on IBOR Fallback Proposals". Could you provide a non-ambiguous and achievable definition of this?

A period "preceding" a given date is not something familiar in the interest rate market. What is familiar is a period "following" a given date. And in the interest rate market, "preceding" is not the opposite of "following". There is not a one-to-one correspondence between them. It is possible (and very frequent) to have a 1 month period starting on different dates and finishing on the same date. Would you mind providing a definition of "1 month period preceding"? And also clarify why you have selected that specific definition by opposition to the many others that could have been selected?

Moreover in ISDA case the multiple workaround to make definitions clear and achievable in practice generated risk management nightmares. This was further described in a blog Fallback transformers: gaps and overlaps and related seminars. As you indicate in the text, the "last reset" methodology creates "hedging challenges". Could you indicate how those are solved for the 1-Month and 3-Month tenors you propose to use?

On the in-advance part, I would like to congratulate you for deviating from the other proposals by using a shorter in-advance period for the 6 and 12 months LIBOR. This is not in line with previous proposals, in particular the July 2018 ISDA consultation, but it is better from all points of view. Your decision to use my proposal, as described in my July 2018 "quant perspective", is positive.

In describing the replacement rate, you use the terminology "Interest period". There is no definition of this term in the regulation. Does it mean that the rate does not depend only on the relevant LIBOR but also of the instrument to which it is applied? Are two instruments fixing on the same date and rate without the replacement still fixing on the same date and rate after it is applied?

The definition of "replacement rate" you proposed is ambiguous and would require some work to be unambiguous. The (unambiguous) definition created by ISDA-Bloomberg, because generated based on an ill-conceived concept like your proposal, is generating tremendous risk management issues. Could you indicate how the approach you proposed will not generate similar issuers.

Also you indicate "hedging challenges caused by the structural differences between the IBOR (as forward looking) and the SARON (as backward-looking)". Those hedging challenges exist also for 1-month and 3-month periods. How do you plan to solve them?

License

According to the new regulation, it is mandatory to use the spreads, which are the ones published by Bloomberg. According to the Bloomberg rule book, a (paid) license is required to use ISDA-Bloomberg rates and spreads. Is a license required to abide by the regulation? Is the EU paying for all the licenses required?

Value transfer

This regulation generates value transfer between the parties in the financial contracts, in particular between the retail mortgage holder and the banks. As indicated by ISDA, the private association at the origin of the spread computation you used, this spread creates "winners and losers". Is there a plan to compensate for the losses resulting from this regulation?

Sincerely yours,

Marc Henrard

P.S. If the Commission has not answered all those questions yet or fail to understand some of them, my consulting services regarding the related quantitative finance complexities are available through muRisQ.

Dear reader, if you have any answer related to the above questions, don't hesitate to add them in the comments.

Added 2021-11-13: The above letter has been sent to Ursula VON DER LEYEN and her Head of Cabinet (Bjoern Seibert) through the email addresses provided on the europa.eu web site. I have not received any aswer to the above questions yet. My guess is that the commission does not have the answers. If my guess is incorrect and I actually receive an answer, I will let you know.

Added 2021-12-02: I have received an answer from DG FISMA, Unit C.3 - Securities Markets. I have publish its content and my answer in another blog.

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