Problems with SOFR, CCP risk and Brexit again

The week on, March 30 – April 5, 2019

7 days montage 050419

Brexit fear drives futures trades out of London

Transitions via FIA protocol have escalated since January as no-deal concerns mount

Fed repo facility may fix SOFR’s image problem

‘Overnight standing repo facility’ could stop year-end rate spikes, and extend Fed’s reach

Will the Nasdaq default spur CVA for CCPs?

Quant proposes a model to calculate bank credit risk exposure to a CCP


COMMENTARY: Libor shrapnel

It’s been more than a decade since started reporting problems with the Libor benchmark. It’s safe to say that since then, pretty much all our worst suspicions have proved correct. Major banks were indeed skewing their Libor submissions, both to give an optimistic impression of their financial health and to improve desk profits. The move to a post-Libor industry, however, is proving to be a long and excruciating process – this week looked at some of the secondary damage the collapse of Libor continues to cause.

Switching to a more reliable replacement for Libor will mean rewriting existing rates contracts – this is not news, and work is already underway on inserting new language into existing contracts to make them compatible. But forward rate agreements (FRAs) could be completely incompatible with a replacement that is backward-looking, rather than forward-looking like Libor. Single period swaps, the most obvious substitute, are thinly traded, and so do not provide an easy substitute.

Other Libor-based contracts already have triggers allowing them to switch to an alternative rate when Libor ceases publication – but regulators are worried this isn’t enough, and that a poorly supported ‘zombie’ Libor could continue to be published, exposing the holders to additional risks. They should have the right to drop Libor when it becomes unrepresentative as well, the regulators argue.

In the US, the Fed is seeking to shore up the claim of the secured overnight funding rate (SOFR) to the throne of US dollar Libor by giving itself the tools to fight the underlying repo rates’ tendency to leap up and down at year-end (not a good look for a new benchmark rate).

The beginning of the end for Libor comes in 2021, when submitter banks will be allowed to stop providing quotes. But Libor itself seems sure to linger on for many years afterwards. The slow death of Libor could easily last 15 years, and 20 is not out of the question.

As it gradually perishes, it would be a useful exercise for risk managers, and more importantly regulators, to periodically look back at the first reports of problems with Libor. They should ask, what else does the financial sector depend on to such a great extent? Is it also based on little more than trust? And if we have a replacement for it, how easy would it be to switch and will we be better placed to respond than we were in the years following 2008?



“With the inclusion of Chinese bonds into global indices, a lot of investors are going to have unwanted foreign exchange and interest rate risk, so they are going to need to use derivatives” – Simon Lau, Goldman Sachs



CME Clearing reported a peak margin breach of $138 million in the fourth quarter of 2018 – the largest since public disclosures began in 2015. Prior to this, the central counterparty’s largest margin breach was $47 million in size, incurred in the first quarter of last year.

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