Benchmark reform, LCH-Eurex basis and FX algo fears

The week on Risk.net, September 9–13, 2019

7 days montage 13091919

LCH sets €STR swap clearing launch date

Clearing house to offer the swaps from October 21, discounted at Eonia

Brexit flips LCH-Eurex basis

LCH-Eurex basis has inverted on buy-side flows, hitting –1.3bp at July low

Algo fears spark hunt for neutral checks on forex code compliance

Banks seek third-party quantitative methods for confirming activities done in their names are aligned with the principles

 

COMMENTARY: Seeking references

Benchmark reform dominated the news pages of Risk.net this week, as a clutch of stories testified to the effort – albeit it sometimes patchy – underway globally to press ahead with the transition from the tainted reference rates banks were fined billions for rigging.

In Europe, LCH is to set begin clearing swaps linked to the European Central Bank’s new euro overnight risk-free rate from October 21. The clearing house’s move follows hot on the heels of Eurex Clearing announcing it will do the same, starting on November 18.

Traders say this will greatly facilitate the transition from Eonia – which authorities plan to eliminate – to €STR.

Over in the US, meanwhile, two banks – Goldman Sachs and JP Morgan – are arguing over how quick the transition should be to switch cleared swaps to a new discount curve – the secured overnight financing rate (SOFR), which will be used to calculate future cashflows and the interest paid on collateral – again as part of benchmark reform efforts.

LCH plans to adopt SOFR discounting on October 17, 2020 – three months after CME. Goldmans thinks, in terms of ensuring liquidity in the market, the move can’t come too soon. JP Morgan, however, favours the later date, and says the clearing houses will need to agree a common line if offsetting trades are to be moved together.

In Asia, however, awareness about benchmark reform could be improved, it is claimed.

A term structure for Singapore’s overnight risk-free rate could come as soon as next year, and Australia is another of the more advanced jurisdictions looking at the issue. But the impact on corporates and non-banks in the region more generally is creating a source of concern for banks that need to adjust lending terms. They are calling on industry bodies and supervisors to educate market participants about the consequences of the likely death of Libor – the benchmark expected to stop being published at some point after the end of 2021.

And in the UK too, the prospect of the demise of Libor has created so far unresolved problems for UK insurers, who are said to face a unique challenge. The European Insurance and Occupational Pensions Authority – the regulator that sets the discount curves insurers use to value their liabilities – has yet to specify plans to change the reference to Sonia and other Libor replacements. This leaves UK insurers in limbo. Do they move their liability hedge to Sonia sooner and create basis risk, or should they remain in a market that will become less liquid over time?

STAT OF THE WEEK

More than 10% of assets held by EU insurers are exposed to climate changed-related risks, a report by European regulators says. The European Insurance and Occupational Pensions Authority analysed insurer assets as of Q1 2018, and found that almost 13%, around €1.35 trillion ($1.5 trillion), would be at risk if the economy were to transition to a carbon-neutral state.

QUOTE OF THE WEEK

“The continued pursuit of various opportunistic strategies in the credit derivatives markets, including but not limited to those that have been referred to as ‘manufactured credit events,’ may adversely affect the integrity, confidence and reputation of the credit derivatives markets, as well as markets more generally” – US and UK regulators jointly calling for the credit derivatives market to clean up its act

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