Compounding, venue disruptors and the Fed’s stress buffer

The week on, January 11–17, 2020

7 days montage 170120

EU compounding confusion creates headaches for banks

With the fallback possibly illegal in some EU states, loan system updates may become more complicated

Trading venues decry disruptors as MTF battle heats up

Unregulated tech vendors accused of operating as de facto venues; a claim dismissed as “entirely outrageous”

Fed’s rush to complete stress buffer likely to unnerve banks

Quarles wants to include it in 2020 CCAR cycle, making bank capital planning “difficult”

COMMENTARY: Pressure for Sonia

This week, looked at whether markets are making progress on the move beyond Libor – and the verdict is a solid “more or less”.

Swaps data from ClarusFT shows some areas are moving rapidly towards risk-free rates, such as the secured overnight funding rate (SOFR) and Sonia. The US dollar futures market, for example, has seen SOFR open interest rise from 2% to 22% of its total over the past year. SOFR swaps show a similar rise.

But, to the immense frustration of London regulators, the same isn’t true for the move of sterling swaps away from Libor to Sonia. There has been no significant move towards Sonia over the past 12 months, and regulators’ patience is wearing thin.

On the morning of January 16, regulators decided the time had come for a clear deadline. The UK Financial Conduct Authority and the Bank of England warned the industry that market-makers should switch the convention for sterling swaps to Sonia by March 2. They want to see “clear evidence of this engagement [with the transition process] from the beginning of Q1 2020” – in other words, immediately. If not, the bank warned, there were “further potential supervisory tools that authorities could use to encourage the reduction in the stock of legacy Libor contracts”.

The next deadline for the industry seems to be mid-2020; at that point, the bank’s Financial Policy Committee will decide whether or not to take supervisory action.

Thursday’s statement was not entirely unexpected – certainly not for readers of and delegates to its Libor summit last year – but it attracted an understandable wave of attention.

An equally interesting issue is: why has the shift from sterling Libor to Sonia, especially at the long end of the swap market, been so torturous and what can be learned from the process?

The real problem from a regulatory point of view may not be the slow transition – infrastructure barriers to wider use of Sonia derivatives are not significant, market participants say, and can be changed relatively quickly, and this week has also seen record volumes of Sonia sterling swap issuance.

Regulatory anger seems to be strongest around the continued issuance of Libor-linked swaps, many due to mature well after the planned 2021 Libor sunset.

Regulators have two possible approaches to follow, which could be described as either “mowing the lawn” or “making an example”.

In the first – which their remarks this week and earlier seem to support – the focus will be market-wide, with the potential for changes in risk weightings either to penalise those firms still holding Libor exposure or benefit those holding Sonia-linked swaps.

However, the second option would see the regulator target a single firm, or a few firms, that have large Libor exposures or large volumes of Libor swap issuance, potentially with an onerous Section 166 review.

Making the review very public would serve as a warning to lesser offenders – at the cost of reputational as well as administrative costs to the firm targeted. This would be a fairly extreme move – but unless the industry has acted significantly by mid-2020, regulatory irritation may have risen to the level required to produce it.


Assets under management in Europe have doubled in the decade since the financial crisis. However, the asset management industry has not been subjected to the level of scrutiny directed at banks over the same period – that is until now, as the European Securities and Markets Authority focuses on investment fund risks and officials look to regulatory reporting for a better grasp of fund leverage and liquidity.



“In our view, initial margin on its own is not a sufficient risk mitigant in isolation. It needs to be complemented by suitable controls in order to prevent members clearing outsized, unhedged positions” – Andrew Dickinson, Bank of America. The case of power trader Einar Aas’ default at Nasdaq Clearing in September 2018, and the default fund’s subsequent loss of $119 million, set alarm bells ringing for banks, CCPs and regulators.

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