Brokers may flout deadline to darken US dollar Libor screens

SOFR First step raises transparency concerns; threatens publication of Ice swap rates

Libor-screens-should-be-switched-off-say-regulators
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Interdealer brokers say they may continue to show US dollar Libor swap prices even after regulators have called for screens to go dark in October.

Under the SOFR First initiative, which is promoting a move to the secured overnight financing rate, brokers are being asked to switch off US dollar Libor swap screens altogether after October 22. But two brokers plan to defy those demands, citing transparency requirements and still-current licensing agreements for these feeds.

“Our role is not to dictate to our risk-taking participants what they can and can’t trade. Our job is to facilitate liquidity. If people need, or want, to trade in Libor, we will continue to facilitate those trades,” says an executive at a swap execution facility (Sef).

“These are not banned products. I believe we have an obligation as a venue to make things available for trading that are ‘approved’ products and subject to trading on venues. Therefore, we can’t just switch them off,” he adds, referring to post-crisis regulation that has led to Sef-trading mandates for various US dollar Libor swaps.

An executive at a second Sef agrees: “The screens cannot be turned off. It’s counter to all the transparency that we’ve built in and around Dodd-Frank. As we get prices in Libor, we’re going to price it.”

The SOFR First initiative covers several recommendations adopted by the Commodity Futures Trading Commission’s Market Risk Advisory Committee (MRAC) and endorsed by the Alternative Reference Rate Committee (ARRC), the Federal Reserve-backed industry group spearheading the US Libor transition.

On July 26, interdealer brokers were recommended to make SOFR the dominant pricing curve for linear swaps and to treat US dollar Libor as a basis to the alternative risk-free rate.

After sending mixed signals in the days after the switch, SOFR liquidity slowly pushed higher. The week of the switch saw 6.8% of US dollar swaps notional volume reference SOFR, up from a weekly average of 3.8% in the six weeks beforehand, according to data reported to the Depository Trust & Clearing Corporation’s swap data repository.

Our job is to facilitate liquidity. If people need, or want, to trade in Libor, we will continue to facilitate those trades
Executive at a swap execution facility

During the first phase of the initiative, interdealer pricing feeds for US dollar Libor swaps can remain in place but are supposed to be for informational rather than for trading purposes. In a second phase, which begins after October 22, regulators have called for those screens to disappear.

“After this date, these screens should be turned off altogether,” the MRAC wrote in an adoption statement.

An interest rate trader at a bank in London called the recommendation to shut off Libor screens “pretty extraordinary”.

“There’ll be people who have trades that need to reference the Libor price since they’re allowing people to continue trading it if you’re mitigating existing risks,” says the trader.

“I don’t think the screens need to be turned off. We can still transition without that. SOFR first is building liquidity in SOFR, and people will go to it because it’s the liquid rate.”

The ARRC hails the first phase of the initiative a success with interdealer swaps pricing and transactions moving “clearly and decisively in favour of SOFR,” according to a spokesperson. “This was an essential step and in keeping with that progress, it’s our understanding that interdealer brokers will turn off their Libor screens altogether in October,” the spokesperson adds.

Swap rate threat

The planned screen switch-off could also threaten publication of swaps benchmarks used to settle trillions of dollars of swaptions contracts. 

Ice swap rates, published by Ice Benchmark Administration, rely on pricing from interdealer broker screens for construction. These rates represent a daily measure of term-Ibor swap rates from one to 30 years and are commonly used in rates structured products. 

Executable quotes from dealer-to-dealer central limit order books sit at the top of a waterfall of inputs for constructing the rates. In the absence of broker screens, IBA would be forced to reach further down the ladder of data sources to continue publishing the rates. Any loss of safety net inputs could put the benchmarks at risk altogether. 

“To the extent that the SOFR First initiative results in interdealer broker screens ceasing to display quotes, or reducing the number of displayed quotes for relevant US dollar Libor-linked swaps, this could result in greater reliance on levels two and three of the waterfall in calculating the US dollar Libor Ice swap rate,” says IBA in a statement on its website.

“Insofar as the initiative results in a reduction of eligible input data at any level of the waterfall, it might consequently impact IBA’s ability to calculate and publish one or more US dollar Libor Ice swap rates.”

A second level would see the rates built from negotiable quotes on Tradeweb’s dealer-to-client platform. A third layer allows rates to be calculated via linear interpolation, providing adjacent tenors publish at the first or second input level.

From the brokers’ perspective, shutting off the screens could also impose a commercial loss if doing so violates existing licensing agreements.

“We have clients that license those pages and buy those pages from us. How do I turn that page off? You want me to go reposition 700 data pages that we have out there? Who’s paying for that?” says the executive at the second Sef.

The requirement to switch off broker screens is a rare divergence from the UK’s Sonia First roll-out, which the US initiative aims to replicate. Sterling Libor swap screens remain switched on at interdealer brokers, yet liquidity has continued to ebb from the legacy benchmark. By March – just five months after the UK initiative took effect – Sonia swap notional volumes outpaced sterling Libor instruments.

“We don’t have that guidance in the UK, and there’s no problem with what’s happening here. All that interbank business is Sonia now, and we have Libor screens that are still dealable,” says the London-based trader.

Turning off Libor prices may not lead to trading difficulties, however, as traders can easily determine the Libor price from the SOFR price and the Libor/SOFR basis, and not all participants see it as a problem.

“It’s just a case of A plus B equals C, rather than a broker market just showing C,” says a US rates trader at a European house.

“I don’t see that as a negative thing. Having these steps in place, like no new Libor trades in December and screens from the brokers going away in October, are all necessary to guide the market to the to the end goal of SOFR,” he says.

While US dollar Libor will be discontinued after June 2023, regulators have called for no new business to be written on the benchmark after the end of this year, with exceptions for certain situations, including the need to risk manage existing positions.

Additional reporting by Helen Bartholomew

Editing by Louise Marshall

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