Interest Rates Archives - Page 3 of 5

USD LIBOR Cessation: 2021 Blueprint Paves the Way but Requires Action Now

With LIBOR transition now in full swing with the first round of major index cessations at the end of 2021, the focus is now squarely on the upcoming USD LIBOR cessation deadline in mid-2023. OSTTRA has been heavily involved in the LIBOR transition from day one and through its various industry solutions. In this article, Vikash Rughani, business manager, triReduce and triBalance and Peter Altero, head of rates business development reflect on the milestones of the recent 2021 LIBOR transition. Read on to learn more about how post-trade market infrastructure adapted across compression, netting and trade processing to support firms as they navigated the 2021 RFR transition and how this post-trade blueprint supports firms as they prepare for the cessation of USD LIBOR in 2023.

MarkitServ has supported the Secured Overnight Financial Rate (SOFR)—the benchmark chosen to replace LIBOR in the US—since 2018, when customers requested the new risk-free rates (RFRs) be added to the OTC derivatives processing platform. At the time, there were no strong data points to refer back to for these RFRs, so MarkitServ worked closely with the industry to agree on the standard conventions and market agreed trade processing capabilities required. This was so that MarkitWire could support the efficient trade affirmation, confirmation and life-cycle event processing of trades referencing SOFR instead of LIBOR. Liquidity has grown significantly since SOFR was first published in 2019. Data from September 2022 showed that around 75% of all new USD swaps were referencing SOFR. (Source: OSTTRA)

A compression roadmap

Once RFRs became available, firms began learning how to price and trade instruments referencing them, book trades in their systems and make sure they seamlessly flowed to all downstream processes, including payments and settlements. Participants began submitting those trades into TriOptima’s triReduce compression cycles, demonstrating that they could extract the transactional information necessary, obtain prices for those SOFR transactions in their portfolios, and that they were comfortable compressing trades and calculating market risk on them. To constrain the effect on market risk, firms set tolerances on the compression platform and carried out the steps needed to be able to compress RFR trades and process them downstream via the central counterparty (CCP).

As volumes started increasing in 2019, TriOptima, in support of the ARRC’s paced transition plan shared its own roadmap for proactively and iteratively reducing exposures to legacy benchmarks. By May 2020, triReduce had compressed its first SOFR swap, which became the template used for USD as well as for any other new alternative RFR. The platform can scale to whatever benchmark the market shows interest in — for example, it compressed its first Bloomberg Short-term Bank Yield Index (BSBY) swap in January 2022.

Benchmark Conversion functionality was also added to triReduce, which is a tool to further assist market participants in both reducing their gross notional exposure to legacy benchmarks and converting the remainder onto new RFRs. Firms can use this new conversion service for both centrally cleared and non-cleared OTC swaps trades and to unlock greater efficiencies.

Liquidity lessons learned from UK transition to SONIA

When the UK market began transitioning from LIBOR to the Sterling Overnight Index Rate (SONIA), there was little liquidity over 18 months, because SONIA swaps had traditionally been a short-dated instrument. For instance, if a firm had a 20-year LIBOR exposure they wanted to convert, there were no equivalent SONIA trades available to replicate or offset against. TriOptima’s innovation extended the capabilities of their service to enable banks to create new trades they were confident to price even though they had not yet executed many similar trades in the new benchmark.

More recently, it has been a similar situation with SOFR. In the beginning, SOFR liquidity did not go beyond three years. The industry had a chicken and egg problem of how to grow the duration of the SOFR curve. So how was this done?

Firstly, trade booking was enabled through the MarkitWire platform, which allowed firms to enter into longer-dated trades. Then there was the discounting switch in 2019, where CCPs’ discounted cash flows for both variation margin (VM) and initial margin (IM) from Federal funds over to SOFR. Overnight, this put firms into long-dated SOFR exposure they needed to hedge. Although it is mostly dealers that are active in hedging their discounting risk, this acted as a significant catalyst for building liquidity at the longer end of the SOFR curve.

A trade processing blueprint for USD LIBOR transition

USD market participants are currently running through questionnaires internally and planning for the upcoming benchmark conversion. OSTTRA has a proven blueprint that was successfully adopted by the industry during the first four currency conversions: Swiss Franc, Euro, Yen and Sterling. The combined experience of Markitwire and triReduce coming together in one company allows for a comprehensive suite of solutions aimed at mitigating risk and providing firms with tools that allow them to manage their exposure ahead of USD LIBOR benchmark cessation.

OSTTRA offers platforms that scale to meet the challenge of larger volumes as well as the functionality to help with the conversion of legacy benchmark risk. OSTTRA also supports the legal aspects of transactions under the International Swaps and Derivatives (ISDA) fallbacks Protocol. In late 2020, MarkitServ partnered with ISDA and engaged with customers via its industry working groups to explain how their rulebook would incorporate the ISDA Fallbacks Supplement and to help dispel any ambiguity as to whether new and legacy non-cleared positions were protected by the Fallbacks Supplement and Protocol. In the few scenarios where it was not straight-forward to determine if such positions were protected by this framework, such as in a legal novation of an existing bilateral transaction, OSTTRA MarkitWire implemented a new field enabling the remaining party and transferee to incorporate the IBOR Fallbacks Supplement.

“2021 brought a lot of change including LIBOR-SONIA conversion, the October 2021 [definition change], as well as all of the Uncleared Margin Rules (UMR) deadlines. When so many industry-wide events occur in short succession, firms tend to focus only on the most imminent priority. As a result, many firms did not take advantage of resources available to them, like the clearinghouse conversion dry runs that were taking place in advance of the CCP Conversion related exercises for Swiss Franc, Euro, Yen and Sterling. This was a missed opportunity that firms will be seeking to learn from this time around.”

Tackling transition burden with netting synchronisation

The conversion of legacy LIBOR transactions into the alternative RFR, SOFR, is a once-in-a-lifetime transition. Building tools or capabilities to support the transition process and consuming message feeds from the clearinghouses represent a meaningful amount of sunk cost for a limited-use build.

The OSTTRA MarkitWire CCP Synchronisation service provides two-way API connectivity between the MarkitWire interface and the clearinghouse, built natively to support different post-trade events on cleared trades. As an example, firms using OSTTRA triReduce to compress trades – with the output of full terminations and risk replacement trades—can simplify their internal build and support costs through the CCP synchronisation API. Most firms which leverage OSTTRA MarkitWire for rates trade processing workflows connect to the interface via a proprietary API which feeds directly downstream into their risk system. CCP synchronisation is built off this same API which consolidates BAU flow with post clearing activity. Firms can reap the benefits of connecting once through a familiar interface to process termination and risk replacement trades across 6 different clearing houses, as well as compression/optimisation vendors who service the cleared interest rates community.

When clearinghouses announced they would perform bulk cleared conversions, the OSTTRA CCP synchronisation tool helped normalise workflows for clearing participants. CCP synchronisation was utilised for both the basis swap splitting exercises and the subsequent legacy benchmark conversion exercises in 2021. OSTTRA supported firms through the conversion events in all four currencies through a standard interface across The Japan Securities Clearing Corporation (JSCC), Eurex, the Chicago Mercantile Exchange (CME) and LCH, resembling a multi-tenant multi-clearinghouse offering. It will now be extended to USD as well as to any further conversion events performed by these and other CCPs.

Instead of multiple—often manual—processes, this is all automated through a single highly-scalable platform. OSTTRA has undertaken extensive performance testing to ensure resilience in the face of the extreme volumes that are widely expected to be processed during these future exercises.

Dry runs offer an opportunity for rehearsal before transition

2021 brought a lot of change including LIBOR-SONIA conversion, the October 2021 definition change, as well as all of the Uncleared Margin Rules (UMR) deadlines. When so many industry-wide events occur in short succession, firms tend to focus only on the most imminent priority. As a result, many firms did not take advantage of the clearing house conversion dry runs that were taking place in advance of the CCP Conversion related exercises for Sterling. This was a missed opportunity that firms will be seeking to learn from this time around.

Considering the sheer size of the USD LIBOR swap population, firms should plan to participate in the dry runs being run by the CCPs. Some are already working with OSTTRA MarkitWire to facilitate the backloading of production-like portfolios into the OSTTRA MarkitWire UAT environment which is linked to test environments of global clearing houses so they can maximise the value of those dry runs.

In addition, firms are preparing to support all variations of SOFR swaps that will be created as part of the CCP conversion exercises and in many instances may not have traded such variations before. Firms prefer to see the results of the USD dry runs feed OSTTRA MarkitWire UAT as the environment is connected to their risk system, enabling portfolio pricing simulations.

A major lesson learned from last year is that firms can never start their planning early enough. At the start of 2021 many firms were surprised that the CCPs were not simply going to implement the ISDA Fallbacks but would legally convert legacy benchmark trades to the alternative RFR. In turn, it took firms some time to understand the corresponding need to reduce their exposure to not only index cessation but also to the CCP conversion exercises by getting down to their core net risk positions.

As part of the CCP conversion exercise, every single trade that is subject to cessation is run through the conversion process, leading to a doubling or tripling of the number of trades in their book. Firms must consider the impact such an explosion in trade count and notional would have on operational processes and technology infrastructure.

Even for non-cleared trades, from both a technological and operational point of view implementation of those fallbacks was not straightforward. Firms have recognised that the shift from term rates to compounded in arrears rates means that whereas a coupon payment would be known three months in advance for a typical LIBOR swap, in a SOFR world, the payment is only known two days prior to payment date. This means firms may only have two days to resolve any breaks with their counterparties. OSTTRA triResolve, the daily reconciliation platform that enables firms to discover and fix breaks proactively, can assist by tracking potential sources of reconciliation breaks throughout the coupon period and until the coupon payment is actually settled.

Compression via OSTTRA triReduce helps shrink the number of outstanding swaps down to the core net risk position and mitigate risks relating to the conversion exercises. It also enables firms to consciously and, in a risk-based manner, convert their risk from legacy benchmarks onto the alternative RFR—whereas the CCP conversion exercises approach it at a trade-level. Between now and June 2023, firms can chip away every two weeks at their ticket count and overall Libor exposure, converting over to SOFR in a single battle-tested process. The more they reduce their pool of outstanding legacy swaps, the less the CCP conversion runs will impact them.

Unique challenges for the USD market

The choice of alternative USD rates was not as straightforward as with other currencies. SOFR is based on a particular segment of the market and most importantly – actual transaction activity. However, that transaction activity is rooted in the repo market. SOFR, a secured rate, behaves very differently from LIBOR by virtue of not having a credit component and not being a term rate.

“The conversion of legacy LIBOR transactions into the alternative RFR, SOFR, is a once-in-a-lifetime transition. Building tools or capabilities to support the transition process and consuming message feeds from the clearinghouses represents a meaningful amount of sunk cost for a limited-use build.”

Key takeaways

Firms should start early and engage their vendors to understand the services available to assist them during this momentous time. They should participate in any dry runs that are offered and encourage consistency where appropriate between clearinghouses.

They should also look at their legacy stock of trades in both the cleared and non-cleared worlds across all global desks & books without forgetting products like non-cleared cross-currency swaps where a significant portion of trades utilise USD LIBOR as the interest rate benchmark on one side.

So much energy has gone into establishing SOFR and making it the market standard over the last four years. Now, even if firms want to transact using LIBOR, this rate is quoted with reference to SOFR. Any LIBOR trades that go beyond the end of 2023, will turn into a quasi-SOFR trade from a valuation and risk perspective and should therefore be viewed as such following the cessation date. Firms then need to assess what their exposure to LIBOR will look like over the next 12 months and how LIBOR volatility might be impacted by the winding down of legacy exposures in the benchmark.

For more information regarding Benchmark Reform click here or contact us.

Authors


Vikash Rughani Business manager, triReduce and triBalance	Peter Altero Head of rates business development

Trade Refactoring Unlocks Additional Compression Benefits

Following the launch of Trade Refactoring one year ago, we have seen an increase in adoption over the last few months. This has enabled OSTTRA triReduce to unlock additional benefits for compression participants, resulting in USD 1 trillion of additional gross notional reduction in LCH SwapClear during September 2022 alone.
Trade Refactoring is the most sophisticated form of portfolio compression available for cleared OTC Interest Rate Swap portfolios and will remain a key tool as major global banking institutions ready themselves for their end of year regulatory reporting requirements.

Benefits:

Enables compression of trades that cannot be compressed by netting or blending
Can be adopted unilaterally, so there is no need for critical mass adoption to achieve efficiency benefits
Sticky trades can now be reduced
Generates a significant one-off reduction and has proven to be at least 10% more efficient at compression than Trade Revision on an ongoing basis

How it works:

Two spot trades that cannot otherwise be compressed in risk-free netting, or in multilateral compression without offsets in the CCP, are replaced with a forward starting trade.

There are no additional submission requirements for firms running with Trade Revision.

Useful Links

Trade Refactoring Press Release

Article Preparing for Further Index Cessation

Portfolio Compression

Managing CCR to reduce the all-in cost of OTC derivatives portfolios

There are a multitude of risk factors that contribute to the cost of trading OTC derivatives and maintaining a derivatives portfolio over time. As the industry transitions to the risk-based calculation method for capital requirements, referred to as SA-CCR, or Standardised Approach to Counterparty Credit Risk, we examine how counterparty credit risk contributes to these costs by highlighting the intricacies involved in OTC credit risk management.

The importance of managing counterparty credit risk effectively became evident during the financial crisis 14 years ago. It subsequently became a central theme in the regulatory changes that followed, including mandatory central clearing, the requirement to secure non-cleared exposures via Variation Margin (VM) and Initial Margin (IM), and, most recently, the implementation of the updated capital regime, SA-CCR. Over time, each of these regulatory initiatives has increased the cost of counterparty credit risk, in turn incentivising effective risk management and proactive mitigation.

Mandatory clearing has made the financial markets more resilient by ensuring that liquid and vanilla risk is centralised, netted down, and facing a financially robust counterparty. However, risk exposures that were traditionally intended to hedge one another but originated from different product types is sometimes scattered between different netting sets, resulting in fragmentation since not all products are eligible, or indeed suitable, for clearing.

The advent of Uncleared Margin

After the introduction of the mandatory clearing rule, regulatory focus switched to the mitigation of bilateral risk, with firms required to exchange margin with their counterparties. This became mandatory for the largest firms in the first wave of the Uncleared Margin Rules (UMR) in 2016/17. UMR thrust counterparty risk back into the spotlight and the cost of funding initial margin has become a real consideration when maintaining an OTC portfolio.

Many of the most active FX trading participants witnessed their initial margin requirements quickly growing since FX positions are typically fragmented across many currency pairs, multiple counterparties and have historically only been cleared or netted to a limited extent. The UMR product scope differentiated between FX products, specifically those with and without physical delivery. This, again, impacted well managed netting sets as non-deliverable risk from FX instruments now attracted bilateral margin, whilst deliverable FX risk did not.

This encouraged the industry to reduce risk using a combination of pre- and post-trade optimisation tools, as well as promoting scalable initiatives to help achieve this. The resulting solutions optimise risk allocation between bilateral counterparties and the CCP(s), which reduces the size of margin calls and the associated funding costs. The clear benefits of these new multilateral services resulted in rapid adoption and incorporation into the banks’ daily operations. These initial solutions were very efficient, given the focus was purely on counterparty credit risk, and left market risk unchanged. In FX products alone, the cost savings achieved through the optimisation of credit risk amounts to savings exceeding USD 100 million annually.

Adoption of the SA-CCR capital regime

The recent introduction of SA-CCR as the standard capital measure for calculating counterparty credit risk altered the dynamics of FX credit risk again, adding another dimension to be considered when minimising the all-in-cost of trading. Existing risk management and optimisation solutions have been extended to include the additional complexity, and new solutions such as selective post trade novation, compression and clearing have been, and continue to be, analysed.

Actively managing FX exposures and counterparty risk for UMR and/or SA-CCR, or concentrating exposures by clearing, can reduce the associated risks and costs. However, the complexity of managing multiple measures and different types of netting-sets all need to be considered simultaneously if firms are to achieve the objective of minimising all-in derivative portfolio costs.

UMR and SA-CCR are both driven by counterparty credit risk, and each of them affects the cost of trading FX. They are interconnected and cannot be considered in isolation – active risk mitigation in one risk measure may result in an adverse impact on the other. They need to be addressed in tandem, not only because of their similarities but also because there are some important differences that are unique to the FX market:

Different calculation models apply which makes the relative value of risk reduction different between SA-CCR and UMR
The range of FX products included in each model differs
- SA-CCR covers all FX exposures and includes cross currency risk
- UMR exempt all deliverable FX risk and classify cross currency differently
Legacy trade populations are treated differently
- SA-CCR covers all exposures irrespective of trade date
- UMR only applies to positions traded after each firm’s respective UMR implementation date
Exposure thresholds applicable to UMR imply that exposures below a certain level do not trigger any margin calls, hence costs, whilst all SA-CCR exposures require capital to be reserved
Capital regulations in certain jurisdictions include a floor, for example the Collins floor for Risk Weighted Assets (RWA), calculated using internal models (IMM) which impacts the relative value of managing UMR, SA-CCR and IMM exposures

Managing the all-in cost of capital associated with OTC derivatives

FX exposures can, for the benefit of both UMR and SA-CCR or IMM, be simultaneously and independently optimised by leveraging the differences in instrument coverage. Clearing increases netting efficiency, reducing the size of outstanding exposures whilst causing deliverable FX transactions to attract additional margin requirements. These incremental costs must be considered when seeking to optimise the all-in cost of maintaining FX exposures via redistribution of counterparty risk, clearing, novation etc. These methods can all be used in isolation, but the best outcome is achieved when applied together to optimise and minimise the all-in cost.
Although some of these properties are specific to the FX market, others are common across asset classes. In interest rate markets for example, mandates have driven the majority of trades into clearing and the instrument scope for SIMM and SA-CCR is the same – thus the optimisation characteristics differ from the FX market.
There are also differences specific to individual firms that can be highlighted, and are important to consider when seeking to actively manage risk to reduce the all-in cost of counterparty credit risk:

RWA calculation using standardised approach vs. internal model (IMM)
Same risk weight facing all counterparties vs. different risk weight depending on counterparty
Potential floor for IMM calculation of RWA capital requirements
Leverage Ratio vs. RWA as constraining capital adequacy ratio
Individual firm’s cost of funding margin vs. the cost of capital (ROE) impacts the value of optimising UMR/CCP IM vs. SA-CCR/IMM

Summary – Significant complexity

The regulatory regime that governs counterparty credit risk contains multiple interdependent measures, applying to similar exposures, which must be considered in totality to avoid an undesirable outcome.
In reality, banks and firms are domiciled in different jurisdictions, have varying levels of portfolio complexity, and different funding costs. All these factors need to be managed concurrently when optimising counterparty credit risk and regulatory costs associated with OTC portfolios.
Complexity is high. To maximise the benefit of actively managing counterparty risk, firms need to apply their own individual preferences and drivers while simultaneously accounting for differences between UMR and SA-CCR, and bilateral and cleared exposures, for all the individual asset classes.
Given counterparties monitor risk in different ways, it is important to manage and optimise counterparty credit risk:

in a large multilateral network facing multiple counterparties
considering the many regulatory drivers and risk factors
leveraging all available optimisation techniques, and
using a process that provides maximum efficiency, repeatability & scalability

Explore our Counterparty Risk Optimisation Service and learn more about our SA-CCR solutions.

Optimising Your Business Under the SA-CCR

The implementation of the SA-CCR has significant implications for the way that banks run their swaps trading businesses. A holistic approach to assessing counterparty credit risk is required to replace the existing focus on gross notional, resulting in a totally different approach for calculating how much capital needs to be held. This means that banks need ways to reduce their counterparty exposure to maintain profitability and remain competitive.

Our panel of experts consider the SA-CCR regulations and what they mean for participants in the OTC derivatives market, and take a closer look at the solutions available for proactive optimisation.

Options to mitigate the challenges of index cessation fallbacks and conversion

We came to learn a great deal about benchmark reform over the first few months of 2021. In what was always going to be a defining year, there is now greater clarity over index cessation, the derivatives fallbacks, as well as the conversion mechanisms being proposed by central counterparties (CCPs) for the impacted trades they clear.

All in all, we can consider the impact of index cessation across the landscape for over-the-counter (OTC) derivatives as presented in figure 1.

Known index cessation timeline

Since March 5, 2021, the spread between the legacy ICE LIBOR fixing and the compounded in-arrears alternative risk-free rate (RFR) has been determined under the process defined by the International Swaps and Derivatives Association (ISDA) 2020 IBOR fallbacks protocol. This spread represents the rate that will be added to a compounded in-arrears calculation of the alternative RFR in order to act as the fallback rate for an ICE LIBOR fixing that is either deemed no longer representative or is not published on a given fixing observation date.

With the fallback spread adjustments now being fixed and published, it removes one source of uncertainty around the cessation. The triggering of the fallbacks has provided market participants with greater legal certainty in relation to outstanding ICE LIBOR transactions. The industry’s focus can now shift to implementing the fallbacks protocol for legacy transactions executed on the ICE LIBOR benchmarks, as well as the associated supplemental fallback language for new swap transactions on the benchmarks.

Fallback implementation challenges

It is now apparent the complexities of maintaining a portfolio of trades on legacy benchmarks and building processes around the fallbacks present numerous challenges to market participants:

Measuring the impact of the fallbacks. Perhaps one of the first actions for a firm is to estimate the impact of the fallbacks and the spread adjustment on their portfolio. Some may consider any post-cessation legacy benchmark exposure to be alternative benchmark exposure due to the fallback language. This will likely depend on acceptance of the doctrine that the market has already priced cessation into observable legacy benchmark swap rates, and is something firms will need to determine for themselves.
Judging the all-in cost of supporting the fallback process until maturity. This includes the implementation cost of systems upgrades, revised operational processes, internal training and the opportunity cost of not proactively converting from legacy benchmarks or potentially utilizing key resources towards other revenue-generating projects. In a year when firms are not only dealing with benchmark reform, but also the next phase of uncleared margin rules and adoption of new capital rules in the standardized approach for counterparty credit risk, supporting each of these changes will inevitably come at a cost.
Understanding the firm’s ability to hedge and manage post-trade events in the legacy benchmark portfolio. It is too early to know how the market’s appetite for new trades in legacy benchmarks will be impacted, even if such trades are purely to offset existing risks. A typical dealer swap portfolio contains transactions with non-standard market conventions and illiquid trades with embedded optionality, as well as trades that are direct hedges to cash transactions that have been maintained over years. Common among all these product types is the need to maintain active cashflow reconciliation once the fallbacks are implemented. In a forward-looking benchmark world, the next coupon payment is known well in advance of its scheduled payment. Falling back to a compounded in-arrears rate, on the other hand, leaves a very short amount of time to identify booking discrepancies that could lead to payment disputes. OSTTRA triResolve for portfolio reconciliation of OTC derivatives transactions is uniquely positioned to assist market participants, given the limited amount of time available to both detect and resolve potential payment disputes.

This is where a firm must consider all of its options. Already mentioned is how the fallbacks protocol and the associated supplement have provided legal certainty over the continued performance on contracts featuring legacy benchmarks. Firms are now able to consider how they can achieve an outcome that is economically equivalent to the fallbacks, but without having to maintain potentially cumbersome fallback processes. Fallback language can be viewed as a necessary safety net, but it shouldn’t provide motivation to run legacy benchmark exposure through to a trade’s maturity. This may place a burden on booking and risk systems, as well as potentially the cost of hedging activities.

Reducing legacy benchmark transactions

By using OSTTRA triReduce’s benchmark conversion mechanism, firms can proactively and iteratively reduce their legacy benchmark exposures and convert them to their chosen alternative benchmarks. Market participants can establish control over the conversion:

Risk-based tolerances can be used to control impacts using the same measures that a firm manages every day. In turn, firms benefit from enhanced control over the pace of their compression and conversion from legacy benchmarks.
Participants submit their own mid-market valuations for all trades in their portfolio, enabling cost-effective compression and conversion.
Whether a portfolio-based or transaction- level approach is adopted, the resulting risk replacement swaps can take many forms:
- In the case of OTC interest rate swaps, the risk replacement trades can be truly market- standard trades or have the fallback spread adjustment applied to the floating leg. Eligible trades could also be cleared, which they will be if mandated.
- For cross-currency swaps, it is possible to convert just one leg at a time or convert both legs in a single step. LCH SwapAgent trades are eligible for compression and conversions, and SwapAgent is also a venue option to which the resulting risk replacement trades can be sent.

Collectively, these should provide tremendous assistance, affording participants the ability to take back some control over benchmark reform. It also means that there is a method of conversion for all OTC swap market participants.

Opportunities beyond cleared portfolios

Much of any remaining non-cleared portfolio consists of trades that are simply not eligible for clearing. These are interest rate derivatives with optionality, swaps that are too illiquid for a CCP to consider as eligible, or cross-currency swaps, which – for the most part – are not clearing-eligible. Adding to that, a portion of swaps that are clearing-eligible would, in theory, generate additional cost and/or risk imbalances that make the act undesirable. For such trades, it is likely that tailored solutions will be necessary for bilateral counterparts or groups of counterparties to be able to agree on a method for exposure reduction or conversion.

There are portfolio-based and trade-level conversion options available for non-cleared trades. At a portfolio level, the objective would be to compress as much legacy benchmark exposure as possible, while simultaneously converting interest rate exposure to alternative benchmarks to achieve greater degrees of legacy benchmark exposure reduction, such as the process for cleared trades. The key difference here is that the choice of replacement trade can be influenced by the participants in the exercise. For instance, it may be preferable to introduce additional cleared risk- compensating swaps to minimize the residual cash that might be generated. Likewise, participants may consider introducing a spread onto the floating leg benchmark to account for differences between the legacy and the chosen replacement benchmarks.

Adding a spread also underlies how a trade-level conversion might be performed because firms that are likely to prefer this method are also likely to favor cashflow preservation. Performing the conversion at a trade level calls for amending as few parameters of a transaction as possible, relating mostly to the legacy benchmark floating leg(s). Firms will be looking at how the cashflow profile might be impacted by the conversion through the introduction of payment lags, as well as the preservation of representative legacy benchmark fixings.

It would seem we are heading towards an unprecedented end to the year as the market readies itself for index cessation and the associated CCP conversion and ISDA fallback implementation. Compression and conversion are themes that will likely surround these milestones and, make no mistake, now is the time for firms to act and take control of their OTC interest rate swap portfolios.

To discuss your benchmark conversion needs, contact info@osttra.com.

Preparing for further Index Cessation

2023 will see the cessation of the interest rate benchmark that was once the most common in the interest rate swap market – USD LIBOR.

This summary shows how we got here and provides the playbook for the next wave of benchmark with planned cessations evens in 2024.

IBOR reform: LIBOR deadlines, where are we now – global outlook Q1 2022 review continued

JPY Swaps

Background: Japan is taking a multiple rate approach. TIBOR (a.k.a. DTIBOR) is expected to continue alongside TONA. Euroyen TIBOR (a.k.a. ZTIBOR) is planned to be discontinued 2 years after LIBOR cessation. JPY-LIBOR ceased publication on December 31, 2021.

TONA has continued its rise, with 95% of JPY swaps executed in Q1 2022 referencing TONA.

CHF Swaps

Background: CHF-LIBOR ceased publication on December 31, 2021.

Here is how the story unfolded with 100% of single currency interest rate swaps executed in SARON in 2022.

CAD Swaps

Background: Canada is taking a multiple rate approach. Reformed/enhanced CORRA will continue alongside CDOR.

CDOR continues to dominate swap volumes, but CORRA accounted for 8% of CAD swaps executed in the last 6 months. That is nearly triple its historic levels.

AUD Swaps

Background: Australia is taking a multiple rate approach. The reformed BBSW is expected to continue alongside AONIA.

Activity in AONIA has been very subdued for quite some time but after picking up in the second half of 2021, it has grown to almost 10% in the last two months.

SGD Swaps

Background: Singapore initially took a multiple rate approach. However, the reform of SIBOR to base it more on transaction data failed and will cease in 2024. SOR is expected to be replaced by SORA.

SORA has continued its rise, with 98% of SGD swaps executed in March 2022 referencing SORA.

Conclusion

The FCA and most other regulators have been clear, LIBOR and many other IBORs will become extinct in the global swaps market. Progress on adoption of new RFRs has certainly been made, particularly in; SGD (SORA) [c.98%], GBP (SONIA) [100%], CHF (SARON) [100%], JPY (TONA) [c.95%] of new trades are traded on the new RFRs. Elsewhere, AUD (AONIA) [c.10%], CAD (CORRA) [8%], EUR (EuroSTR) [c.20%], and USD (SOFR) [c.60%]. So, while for some currencies the journey is complete, for others the journey continues.

Final thought
With this seismic shift in the products traded in the global OTC derivatives markets, it is reasonable to consider whether there has been any impact on market structure. Well, recently I was approached by a European regulator focussed on the benchmark transition asking when we would be publishing our next update on IBOR versus RFR volumes, (here it is!), and asked whether there is any difference in the trading location data between existing IBORs and the new RFRs. Well to find out the answer, read my piece on the Brexit impact on trading location: Global OTC IRS markets – Q1 2022 review.

Back to beginning

1 2

IBOR reform: LIBOR deadline approaches, flash update on progress in Q4 continued – P2

JPY Swaps

Background: Japan is taking a multiple rate approach. DTIBOR is expected to continue alongside TONA. ZTIBOR is planned to be discontinued 2 years after LIBOR cessation. JPY-LIBOR will cease publication on 31st December, 2021.

TONA has continued its rise, now >70% of JPY swaps executed in November, from 60% in September, up some fifteenfold from 4.5% in June.

CHF Swaps

Background: CHF-LIBOR will cease publication on 31st December, 2021.

SARON has had a significant uptick to almost 80% of CHF swaps executed in November, up from 64% in September, almost trebling from less than 30% in June.

CAD Swaps

Background: Canada is taking a multiple rate approach. Reformed/enhanced CORRA will continue alongside CDOR.

There has been little change with CORRA continuing to make up less than 5% of CAD swaps executed in most months.

AUD Swaps

Background: Australia is taking a multiple rate approach. The reformed BBSW is expected to continue alongside AONIA.

Activity in AONIA has been very subdued over the last 12 months but suddenly increased to 5% of AUD swaps executed in September, October and November, up from 1% in June.

SGD Swaps

Activity in SORA had been very subdued over the last 12 months but having suddenly increased to over 70% of SGD swaps executed in September, it was over 90% in October and November. This was just 15% in June and less than 5% in May…

Conclusion

The FCA and most other regulators are clear, LIBOR and many other IBORs will become extinct in the global swaps market. Progress on adoption of new RFRs has certainly been made, particularly in; SGD (SORA) [>90%], GBP (SONIA) [>80%], CHF (SARON) [~80%], JPY (TONA) [>70%] of new trades are traded on the new RFRs. There is clearly still a way to go to see the new RFRs completely replace the IBORs in global swaps trading.

There has even been progress in:

SOFR now >25% of USD swaps, driven by the SOFR first initiative
EuroSTR now 15% of EUR swaps, as firms stopped trading EONIA

What’s next?
With more significant milestone dates approaching we expect to see further shifts in the OTC interest rates swaps landscape. We will be back in 2022…

Back to beginning

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IBOR reform: LIBOR deadline approaches, flash update on progress in Q4

As the deadline for LIBOR cessation in GBP, CHF, JPY and EUR fast approaches we thought we would break our normal cycle of quarterly reviews and assess how much progress has been made in Q4 2021 so far.

Our previous IBOR transition reviews are available here; Q3 2021, Q2 2021 and Q1 2021.

OSTTRA, through its post trade processing service MarkitWire, has been facilitating the migration of legacy cleared portfolios from IBORs to RFRs. MarkitWire has processed over 700,000 trade sides for more than 100 counterparties over several months, including, most recently, over 500,000 trades across the weekend of 4th December as part of the CHF, EUR, JPY CCP LIBOR conversion events. The next major event is the GBP LIBOR conversion event which is set for the weekend of 17th December.

In addition, OSTTRA’s triReduce service has been compressing legacy IBORs as part of its compression service. So far this year, triReduce has compressed almost $55 trillion of notional, for almost 70 entities in the three December 2021 LIBOR cessation currencies GBP, JPY, CHF. Including USD-LIBOR, and dependent currency indices, triReduce compression reached almost $150 trillion of notional, for almost 100 entities in the LIBOR cessation currencies year to date.

OSTTRA has assessed the data processed by our MarkitWire platform to evaluate the progress during Q4 of interbank offered rate (IBOR) transition for the $355 trillion single currency interest rate swaps (IRS) market. Analysing market share in; EUR, GBP, USD, JPY, CHF, AUD, CAD, and SGD between legacy IBORs, legacy / continuing overnight index swaps (OIS) and the new risk-free rates (RFRs).

How has the market share of RFRs evolved since the start of 2020?

GBP Swaps

Background: Reformed SONIA will replace LIBOR which will cease publication on 31 December, 2021.

Reformed SONIA makes up almost 80% of new trades executed. However, this has barely changed since August…

….and over 90% of the notional traded.

EUR Swaps

Background: EuroSTR (a.k.a. €STR) will replace EONIA. There was an initial uptick at the end of July 2020 driven by the CCPs switching from EONIA to EuroSTR discounting on 25th July 2020. It is expected that EURIBOR will continue to be published until at least 2025 but that there will be a material migration to EuroSTR. EUR-LIBOR will cease publication on 31st December, 2021 but it is not traded in the swaps market, there have been <10 trades a month for many years.

EuroSTR has jumped from 4.5% of EUR swaps executed in September, to 15% in November. As EONIA fell from 12% to 0%. Remember EuroSTR was just 2.8% in June 2021!

… and approximately a quarter of notional traded, up from 7% in September!

USD Swaps

Background: SOFR will replace Fed Funds and USD-LIBOR, although the ARRC have recently approved a Term-SOFR whose adoption will be interesting to watch… There was an initial uptick in SOFR at the end of October 2020 driven by the CCPs switching from Fed Funds to SOFR discounting on 16th October 2020. Unlike the other LIBORs, it is expected USD-LIBOR will continue to be published until June 30, 2023, albeit “SOFR first” applied to interdealer swaps from 26th July 2021.

SOFR has continued its charge, with the SOFR first initiative driving SOFR up to 26% of USD swaps executed in November, versus 17% in September, and up some eightfold from 3% in June. BSBY swaps have traded every month since September but remain <0.01%!

… and approximately 30% of notional