Internal models, last look and SOFR

The week on, July 27–August 2, 2019

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FRTB internal models in fight for survival

Basel III capital floor leaves banks struggling to justify own-models approach, say risk experts

Forex ‘last look’: how non-banks stack up

Research shows patchy disclosures, plus differences from banks on pre-hedging and rejected orders

JP Morgan first to issue SOFR-linked preferred stock

BofA, Goldman Sachs and others are also preparing for Libor’s end


COMMENTARY: They think it’s all SOFR

Some good news this week on benchmark reform and the adoption of the new US secured overnight funds rate (SOFR): JP Morgan made the move away from the Libor benchmark and issued SOFR-linked preferred stock for the first time. A previous debt issue used Libor, but included SOFR – still not yet in existence – as a fallback, and other banks have done similar deals. But this is the first to cite SOFR as its first preference.

Also, LCH SwapClear set an October 2020 deadline for its switch to SOFR to calculate interest on collateral and discount rates, covering $154 trillion in rate derivatives. It isn’t the single big bang that observers had hoped for – rival clearing house CME Clearing earlier set July as its own deadline – but it means that LCH has cracked the problem of appropriate compensation for its users, offering them the choice of a cash payment or a compensating swap.

Even though this isn’t a Libor replacement, there’s a Libor angle here as well – anything that creates more liquidity and activity in SOFR will help the switch run more smoothly as the 2021 deadline approaches, after which banks will no longer be required to contribute to the benchmark.

All this is good as far as it goes – as are other developments like the Bank of England’s intent, announced last month, to rid its balance sheet of Libor-linked collateral, by one of three increasingly dramatic policy options. But with a choice of three possible replacements for sterling Libor on offer, the picture looks hazier for sterling Libor users than for US dollar users. And the overall picture among banks, dealers and buy-side users does not look promising, as reported last month; some have made good progress towards moving away from Libor by the end-2021 deadline, but many more have not.

So there’s a lot left to do. Yes, there is likely to be a steady stream of encouraging news about institutions and market infrastructures gradually shifting away from Libor. But it is uncertain whether enough has been done to avoid market-crippling uncertainty in a couple of years. Because while it’s hard to imagine an unexpected catalyst that makes the Libor transition smoother and faster, it’s very easy to imagine events that would get in the way.



Traded volumes of US dollar basis swaps surged to nine-month highs in July as firms reacted to rising uncertainty in the rates market, with one dealer said to have traded upwards of $30 billion in swaps alone. More than $80 billion of basis swaps were traded on July 11 and again on July 17, followed by $64 billion on July 18, compared to daily average volumes of $27 billion in 2019 to date. Basis swaps spike amid US rates chatter



“From a marketing point of view, people are making AI sound like a transformative story. I don’t think it is” - Andrew Dyson, chief executive, QMA Asset Management

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