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:
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.

Contact us at info@osttra.com to learn more or request a demo.

 

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:

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:

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:

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:

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:

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.

Benchmark Your Operational Performance Against 1,200+ Peers

Gaining a clear understanding of where you stand compared to your peers can unlock valuable insights and drive strategic improvements.

Our new Operational Performance Metrics service empowers you to do just that, offering access to an extensive network of over 1,200 firms across Rates, Equity, and Credit for unparalleled benchmarking capabilities. With fully interactive metrics, you can delve deep into individual asset classes or analyse performance across your entire portfolio on MarkitWire and TradeServ.

This centralised platform provides a strategic view of your operational data, enabling you to:

  1. View Rates, Equity & Credit metrics across legal entities, products and counterparties in one place.
  2. See your operational metrics benchmarked against industry peers to optimise your performance.
  3. Utilise your existing DMS user accounts for a simple and convenient onboarding process.
  4. Have a centralised view of your shared performance metrics for you and your counterparties and customise your data in a way that makes sense for you and your firm.
  5. View your peer and industry rankings per asset class to help improve STP efficiency for that asset class.

Ready to unlock the full potential of your post-trade operations and gain a competitive edge? Download our Operational Performance Metrics factsheet today to learn more about how this new service can help you optimise post-trade efficiency and improve STP rates:

 

OSTTRA Operational Metrics for MarkitWire and TradeServ data

 

Discover the power of industry benchmarking and take your post-trade performance to the next level. To discuss your post-trade operational transformation needs, please 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

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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

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.

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:

 

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

 

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

As the deadline for LIBOR cessation in GBP, CHF, JPY, and EUR passed in December 2021 we thought we would take a look at the data to get the latest picture of global IBOR reform as of Q1 2022.
Our previous IBOR transition reviews are available here: Q4 2021, Q3 2021, Q2 2021 and Q1 2021.

 

OSTTRA through its post trade processing service MarkitWire facilitated the migration of legacy cleared portfolios from IBORs to RFRs in CHF, EUR, GBP and JPY as part of the CCP LIBOR conversion events. MarkitWire processed over 1,000,000 trade sides for over 100 counterparties, through its CCP Synchronization service, over several months culminating in the final GBP run on December 17th.  The industry is now busy preparing for the USD transition that will take place mid-2023.  The OSTTRA team is already discussing this transition with impacted stakeholders and will be ready to support all events linked to the transition, including the highly anticipated transition dry runs.

In addition, OSTTRA’s triReduce service compressed legacy IBORs as part of its compression service. In Q1 2022, triReduce has compressed its largest amount of USD notional since 2018 reaching $32 trillion for over 50 entities which also includes dependant currency indices (SGD and THB).

OSTTRA has assessed the data processed by our MarkitWire platform to evaluate the progress 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 has replaced LIBOR which ceased publication on 31 December, 2021.

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

 

EUR Swaps

Background: EuroSTR (a.k.a. €STR) has replaced EONIA. 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 ceased publication on December 31, 2021 but hadn’t been materially traded in the swaps market for at least a decade.

EuroSTR has jumped to over 20% of EUR swaps executed. Much of this came from EONIA’s demise but EURIBOR has fallen from just under 90% to just under 80% over the past 6 months.

 

… and approximately 60% of notional traded.

 

USD Swaps

Background: SOFR will replace Fed Funds and USD-LIBOR, although the ARRC have 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, over 60% of new USD swaps executed in March 2022 referenced SOFR, continuing a month-by-month march forward. BSBY swaps, a credit sensitive rate, have traded every month since September but remain <0.1%.

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