The increase in monthly volume of cleared notional in swaps based on the new sterling risk-free rate shows that the derivatives market is making progress in moving away from Libor.
Edwin Schooling Latter, director of markets and wholesale policy at the UK’s Financial Conduct Authority, gave a speech on Libor transition at the International Swaps and Derivatives Association’s annual legal forum in London today.
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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 which are based on transactions as they are harder to manipulate and more representative of the market. The UK is adopting the Sterling Overnight Index Average (Sonia) as its risk-free rate to replace sterling Libor.
Schooling Latter said the share of cleared sterling swaps referencing Sonia has grown over the past two years to 19% in the second half of last year, from 11% in the first half of 2016.
Edwin Schooling Latter, FCA
“In notional terms it is a far higher share,” he added. “In fact, on a monthly basis, cleared notional in Sonia swaps is now higher than that for sterling Libor.”
He cited data from LCH, the London Stock Exchange Group’s clearing house, which shows growth in the use of swaps referencing the new risk-free-rates replacing yen, Swiss franc and US dollar Libor rates - Tona, Saron and SOFR respectively.
LCH has cleared $78bn in Tona swaps so far this year and $21.7bn in Saron swaps so far in January. He said: “Of the relatively small $17bn SOFR notional outstanding, $7bn was cleared in the past two weeks."
Schooling Latter continued that even in SOFR, LCH has registered the highest levels of activity to date on a number of measures since the start of this year. In the futures market average daily trading volume in Sonia and SOFR futures both reached 15,000 contracts last month.
Outside the derivatives markets, Schooling Latter added that a total of £6.9bn ($9bn) in sterling floating rate notes using Sonia were issued between June and December last year.
“Already in 2019, by Wednesday last week, we had seen a further £7.2bn,” he said. “If past weeks are a guide, new sterling floating rate note issuance is only Sonia-based now. We have also seen $46.3 billion in SOFR-referencing US dollar floating rate notes.”
Schooling Latter continued that the market took a significant step forward last year by agreeing how to calculate a fallback rate that could replace sterling, yen and Swiss Franc Libor in outstanding contracts after an Isda consultation.
He also warned:”Let me be clear, however. We think that the best and smoothest transition from Libor will be one in which contracts that reference LIbor are replaced or amended before fallback provisions are triggered.”
In addition, he stressed that triggers should be aligned across non-cleared derivatives, cleared derivatives, and cash markets in order to maintain hedging relationships.
Cash markets
A panel at the ISDA conference also discussed ‘The Route to Benchmark Reform.’
Frances Hinden, vice president, treasury operations at Shell International and co-vice chair of the working group on sterling risk-free reference rates at the Bank of England, said on the panel that the group is focussed on creating a term risk-free rate, examining the impact of the new rates on hedge accounting and the use of Sonia in cash markets.
Hinden said: “The first syndicated loan referencing using Sonia would be a triumph.”
She continued that not all banks are ready to use Sonia, and all the banks in a syndicated loan need to agree to change the rate.
“Everyone is hoping that someone else will do something,” Hinden added. “We are stuck at traffic lights trying to get out of the car park.”
Ester
The European Union has selected the euro short-term rate (Ester) as the euro risk-free rate and replacement for EONIA, but Ester has not yet been published. The European Central Bank is due to publish Ester by October 2019 at the latest.
Carlos Molinas, global head of business compliance at Crédit Agricole CIB admitted on the panel that Europe had to catch up with other markets.
“The EU issued a consultation paper last month and responses are due by Friday,” he added.
Molinas continued that the situation is urgent in Europe as new benchmark legislation in the region will stop historical rates applying from January 2020.
Natasha Cazenave, head of the policy and international affairs directorate at AMF said French regulator would support extending the date when the benchmark regulation comes into force.
“Users have no choice but to move to Ester,” said Molinas. “If we shift the deadline there will be no incentive to move.”
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