Intercontinental Exchange and London Stock Exchange Group have launched indicative term Sonia rates to help the industry transition from Libor, the benchmark interest rate which regulators aim to replace by the end of next year.
The Bank of England’s UK working group on sterling risk-free reference rates has recommended that the new term rates are built from transactions of Sonia-linked overnight interest rate swaps and that they are tested for six months.
ICE Benchmark Administration is producing a beta version of Term Sonia Reference Rates over one-month, three-month and six-month tenors on a daily basis.
Stelios Tselikas, chief operating officer at ICE Benchmark Administration, told Markets Media: “We have a robust waterfall methodology using the best available data. In level one, we are using data from three trading venues - BGC, Tradition and TP ICAP.”
After the financial crisis there were a series of scandals regarding banks manipulating their submissions for setting benchmarks across asset classes, which led to a lack of confidence and threatened participation in the related markets.
As a result, regulators have increased their supervision of benchmarks and want to move to risk-free reference rates based on transactions, so they are harder to manipulate and more representative of the market. The UK has chosen the sterling overnight index average, Sonia, as its risk-free rate.
IBA uses tradeable bid and offer prices and volumes for eligible Sonia-linked overnight interest rate swaps available on the central limit order books of BGC Trader, i-Swap and Trad-X platforms during a two-hour window before the relevant calculation. If these trading venues do not provide sufficient eligible data, the second level of the waterfall uses Sonia-linked futures data from electronic trading venues.
“We have received enough data from the multilateral trading facilities to compile the term Sonia reference rates and liquidity has been growing,” added Tselikas. “There are a number of insurance policies in place such as a fallback to Sonia-linked futures data if needed.”
FTSE Russell, the London Stock Exchange Group’s index, data and analytics provider, is also publishing daily indicative term Sonia reference rates (TSRR) for 1-month, 3-month, 6-month and also 12-month tenors.
Scott Harman, global head of fixed income and multi asset index product management, ISD at London Stock Exchange Group, told Markets Media: “As an index provider it is a natural fit with our operating model and we can facilitate the industry reducing its use of Libor. We recognise there is a commercial tension to provide the rates at a reasonable price but believe we can develop a sustainable model.”
He continued that FTSE Russell has been obtaining Sonia swap data from two inter-dealer brokers since March.
“There is a nascent market for electronic quotes but it is getting stronger,” Harman added. “The methodology will evolve and we may include more data from within the group such as futures transactions from CurveGlobal or cleared swap data from LCH.”
CurveGlobal is LSEG’s fixed income derivatives trading venue and LCH is the group’s clearing arm. FTSE Russell intends to form an advisory committee comprising a broad range of market participants including market makers and TSRR end users.
"We have the advantage of being part of a broader exchange and assets under management of $15 trillion tracking our indices,” said Harman. “We are discussing partnerships with stakeholders in the ecosystem which will be novel.”
FTSE Russell’s beta term rates go out to 12 months but if there is interest the tenor could be extended further. “We could also launch SOFR in beta before the end of this year,” added Harman.
The US has adopted the secured overnight financing rate, SOFR, as its risk-free rate to replace US dollar Libor.
ICE term Sonia reference rates rates are published daily on the firm’s RFR portal which was set up October 2018 to provide a comprehensive source of information for the market on alternative reference rates and receive feedback.
“We are working hard at IBA to produce tools to help market participants with their transition needs and are working hard to raise awareness of the tools available to help drive adoption,” said Tselikas.
Term €STR
Tselikas said: “At IBA, we believe that a consistent approach across geographies could be helpful for users of term rates.”
The International Capital Market Association said in its latest quarterly report that Euribor is not currently scheduled to be discontinued but European Union authorities have also highlighted that users should be prepared for all scenarios, including the rate’s possible disappearance.
https://twitter.com/ICMAgroup/status/1281517183319842817
“The Euro RFRWG therefore recommends that market participants incorporate fallback provisions in all new contracts referencing Euribor; and where no specific fallback provision is recommended, a generic Euribor fallback provision should be incorporated instead,” said ICMA. “To this end, the Euro RFRWG is identifying €STR-based fallbacks for Euribor in the event that Euribor permanently ceases to exist, and expects to release two related public consultations in the course of 2020.”
The European Central Bank said in a meeting this month that IHS Markit, EMMI-ICE IBA, Refinitiv and FTSE Russell were the four potential providers of intended forward-looking fallback euro rates.
EMMI, the European Money Markets Institute, administers Euribor and term €STR would be the fallback for Euribor. Tselikas continued that EMMI and IBA are working to develop the best possible term €STR that could be used as a potential fallback to Euribor.
“For the development of the term €STR, we take the recommendations of the risk-free rate working group into consideration, as well as the outcome of the consultations they have organised so far, to offer the most suitable fallback solution to all Euribor users,” he added.
Regulators
The UK Financial Conduct Authority said two years ago that it will not compel panel banks to submit to Libor beyond 2021, and has confirmed this timeline has not changed despite the Covid-19 pandemic.
Andrew Bailey, governor of the Bank of England, said in a speech this week: “What we saw in financial markets in March in response to the shock of Covid only reinforces the importance of removing the financial system’s dependence on Libor in a timely way.”
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He was speaking in an online discussion alongside John Williams, the head of the Federal Reserve Bank of New York, who also said the Covid crisis would not lead to an extension of the 2021 deadline.
Bailey explained that in the week of 16 March this year, as central bank policy rates were reduced to historically low levels, transaction based submissions in three-month sterling Libor fell to zero.
“Over half of the 35 published Libor rates across all currencies contained no transaction based submissions at all during that same week,” added Bailey. “By contrast, the value of transactions underpinning Sonia, the chosen alternative in sterling markets, increased from an average of around £40bn per day to over £60bn in April.”
In addition the UK central bank will begin publishing a freely available compounded Sonia index from next month.
Bailey continued that from October UK banks should all be offering alternatives to Libor.
“We would not expect to see any further sterling Libor linked lending after the end of March 2021,” he said. “Regulated firms in the UK should expect their supervisors to monitor and discuss their progress with these important milestones.”
BIS said this month that continued reliance of financial markets on Libor poses clear risks to global financial stability.
https://twitter.com/BIS_org/status/1281216042501582848
The regulator’s report includes three sets of recommendations to support Libor transition that should be applicable to all jurisdictions with Libor exposures.
“Libor transition is a G20 priority and the report responds to the G20 request to identify remaining challenges to benchmark transition and to explore ways to address them,” added BIS. “The report will be delivered to G20 Finance Ministers and Central Bank Governors ahead of their virtual meeting on 18 July.”
