Sunday, 10 November 2019

Change in collateral rate at CCP: quant perspective

CCPs have announced that they will change the PAI/collateral rate in USD from Effective Fed Fund rate (EFFR) to SOFR. This will be done as a big bang approach, not in line will the planned paced transition set by ARRC in 2017. The planned date for the big bang transition at CME and LCH is Friday 16 October 2020. Some description for CME can be found on their website; we have not found a similar description for LCH, even if it appears that the methodology will be similar.

Such a big bang approach does not offer the "choice between clearing swap contracts into the current PAI/discounting environment or one that uses SOFR for PAI and discounting" as planned by the ARRC. The change is forced on market participants at a price and with a methodology selected by the CCPs.

Such an approach creates the opportunity for value transfer between market participants and may generate unintended consequences. We have detailed some impacts, potential consequences and open questions in a technical document now available freely on a preprint server.

The document, in the muRisQ Advisory Market Infrastructure Analysis series, is titled

SOFR discounting transition: multi-curve and quantitative perspective.

and is available on SSRN with the reference

Henrard, Marc P. A., SOFR discounting transition: multi-curve and quantitative perspective. Market Infrastructure Analysis, muRisQ Advisory, October 2019. Available at SSRN:

Monday, 28 October 2019

Answer to the ISDA consultation on Final Parameters for the Spread and Term Adjustments

ISDA third consultation regarding IBOR fallback closed last week. As for the previous consultation, we have provided a detailed answer. The text of our answer can be found on SSRN:


The consultation asks many questions related to technical details for the IBOR fallback term. Unfortunately it does not consider the main issue, which is that the proposed base solution of compounded setting in arrears is ill-conceived. It fundamentally changes the meaning of IBOR fixing and the question and workaround related to the term are the consequence this ill-conception. Most of the questions consists of workaround for issues that have been described in detail over the last 18 months.

The spread part also focuses on narrow technical questions on how to compute it. It does not answer the question on how to prevent this computation to harm end users through the implied massive value transfer.

We suggest once more to ISDA to review the decision to base the fallback on the compounding setting in arrears and historical mean approaches.

Associated documents:

The answer should be read in conjunction with our previous answer and publication, including a couple of paper in peer reviewed journals.
  1. Answer to``Consultation on Certain Aspects of Fallbacks for Derivatives Referencing GBP LIBOR, CHF LIBOR, JPY LIBOR, TIBOR, Euroyen TIBOR and BBSW'' issued by ISDA. October 2018. Available at
  2. LIBOR Fallback transformers! Market Infrastructure blog, muRisQ Advisory, October 2018. Available at
  3. A Quant Perspective on IBOR Fallback consultation results. Market infrastructure analysis, muRisQ Advisory, January 2019. Available at
  4. Answer to ``Supplemental Consultation on Spread and Term Adjustments for Fallbacks in Derivatives Referencing USD LIBOR, CDOR and HIBOR and Certain Aspects of Fallbacks for Derivatives Referencing SOR'' issued by ISDA. July 2019. Available at
  5. Answer to ``Consultation on Final Parameters for the Spread and Term Adjustments in Derivatives Fallbacks for Key IBORs'' issued by ISDA. October 2019. Available at
  6. LIBOR fallback and quantitative finance. Risks, 7(88), August 2019.
  7. LIBOR: Don't fallback, step forward. Wilmott Magazine, November 2019, to appear.

Thursday, 3 October 2019

Rate reform: a recognised expertise

Over the coming years, one of the main issues in interest rate trading and risk management will be the emergence of new benchmarks and the potential IBORs fallback.

In the past year, we have looked at those issues from a theoretical and from a practical point of view. Some of the theoretical issues are detailed in a note that Marc published recently called "A Quant Perspective on IBOR Fallback Consultation Results" ( Our answers to the different ISDA consultations are also available on SSRN. On the practical side we have implemented different fallback options, curve calibration mechanism and convexity adjustment to analyze the impacts on large portfolios. Some descriptions of the tools are available in a series of previous blogs.

Our expertise has been recognized by the market as documented from the invitations to many practitioner and academic finance conferences and seminars. Marc has been invited as guest speaker or expert panelist at the following events:
We are also presenting in-house workshops on similar subjects (see our training page on LIBOR) at different financial institutions in Europe.

Don't hesitate to contact us if you want to discuss potential in-house training or providing expertise on this subject for your projects.

Monday, 30 September 2019

New benchmarks, LIBOR transition and fallback.

With the increased expectation of some LIBORs discontinuation, the overnight benchmark changes and the increasing regulatory requirements related to benchmarks, a clear quantitative finance perspective on the impacts for benchmark-linked derivatives is becoming paramount.

Financial institution and the end-users of interest rate derivatives face many challenges when navigating through those changes and their impacts. The impacts are far reaching and relate to not only to the legal and operational issues but also to pricing, risk, modelling, validation and implementation in systems.

muRisQ Advisory has an extensive experience related to benchmarks and LIBOR transition. We have published on the subject since more than 2 years and have modelled and implemented the impacts in theory and in practice. We have been guest speaker at major academic and practitioner conferences in the last 18 months (see partial list).

We have help institutions in this regards in several ways:

Technical workshops

  • Public workshops. Planned next presentations: WBS Quantitative Finance conference (Rome, 16 October 2019), RiskMinds (Amsterdam, 6 December 2019)
  • In-house tailor-made workshops on the quantitative finance impacts (valuation, risk, value transfer, model validation, new instruments). Typical agenda available on our training page.

Independent impact assessment

  • We use our own production grade systems developed over the last years
  • Run existing different hypothesis for fallbacks and spreads on exiting portfolios
  • Analysis of re-papering and protocols impacts
  • Analysis of value transfer on actual portfolios

Implementation advisory

  • Support of quantitative analysis and risk groups in implementation (based on more than two years of internally developed research and systems)
  • New models development
  • Senior stakeholder support
  • New exchange traded products development
  • Reduction of existing exposure
  • Support for negotiation with counterparties

Thursday, 29 August 2019

RiskMinds International: The future of LIBOR workshop

Marc Henrard will present a workshop at

RiskMinds International 2019.

The talk will take place on Friday 6 December 2019 in Amsterdam. The details of the workshop can be found on the organizer web site:

We can offer you a 10% speaker discount for RiskMinds. Contact us to obtain the code.

Marc's workshop, will be titled The future of LIBOR.

Workshop's overview:
With the increased expectation of some IBORs discontinuation, the overnight benchmark changes and the increasing regulatory requirements related to benchmarks, a clear quantitative finance perspective on the impacts for benchmark-linked derivatives is becoming paramount. The recent regulations include the EU Benchmark Regulation (BMR) which will have a severe impact on the EUR market from January 2022. For all major currencies, new benchmarks have been proposed and the market are in a transition phase. Each transition has his idiosyncrasies and a common transition approach cannot be expected. On the EUR side, a recalibration approach with clean discounting has been proposed for EONIA. This will happen as soon as 2 October 2019. This changes have potentially important value transfer impacts. On the fallback side, several options have been proposed and ISDA is holding consultations on some of them. The results of the first ISDA consultations has been to select the ``compounding setting in arrears" adjusted rate and the "historical mean/median" spread approach. We present those options and emphasise their drawbacks. In particular the compounding setting in arrears lack of details and, in the words of ISDA, is not workable for some products. We also present alternative options supported by different working groups. The historical spread option can lead to significant value transfer, some of them having already taken place. We present historical data is several currencies to support the theoretical developments. The presentation focuses is on the quantitative finance impacts for derivatives.

October 2019 update: ESTR has now been published since 2 October and EONIA re-calibrated to ESTR+8.5bps. New consultation on fallback parameters and tenors have been issued, new value transfers have been observed. On top of this, CCPs have announced their transition plan from the current ON benchmarks (Fed Funds and EONIA) to the new ones (SOFR and ESTR). More opportunities to make or lose money if you understand the fine quantitative details of the transition or not.

Graphical representation of elements of my personal filtration related to the fallback.

Don't hesitate to reach out if you want to meet at RiskMinds.

Monday, 26 August 2019

CQF Institute: LIBOR - Don't Fallback, Step Forward

Marc Henrard will speak at the

CQF Institute.

The talk will take place on Wednesday 18 September 2019 in London. The details of the talk can be found on the organizer web site:

Marc's talk, will be titled LIBOR - Don't Fallback, Step Forward.

Talk's overview:
With the expected discontinuation of the LIBOR publication, a robust fallback for related derivatives is paramount. In recent months, several consultations have taken place on the subject. To the author's point of view, the proposals are not satisfactory. In this talk, we describe why the main proposal is not achievable in practice and a fundamental revision of the fallback's foundations is required. The talk will then focus on the value of transfer coming from the adjustment spread computation. Part of the transfer has already taken place and more will take place in the future. The source of the value transfer is analysed. A quantitative analysis of the spreads is provided and compared to recent market movements.

Don't hesitate to reach out if you want to meet after the talk.

Tuesday, 2 July 2019

Presentation at Cass Business School - Planning for the end of LIBOR

Marc Henrard has presented a seminar at the conference

Planning for the end of LIBOR

organized by Cass Business School in London on Wednesday 19 June 2019.

The conference was well attended with more than 200 people registered.

Copyright © 2019 by Cass Business School
Introduction to the presentation

Copyright © 2019 by Gianluca Fusai
Marc explaining the intricacies of the fallback spread calculation and its impact on today's valuation.

Saturday, 29 June 2019

Change in collateral rate - fair compensation

The transition from EFFR to SOFR as collateral rate has an important impact in term of valuation. This change is very different from the change from LIBOR discounting to OIS discounting. The LIBOR/OIS discounting was a change of valuation formula from one that was used up to then to a new one that the users though was better. It was a correction of an internal valuation process but there was not change in the term sheet of the products. The pay-off were unchanged. No compensation was required.

The collateral transition is a very different prospect. In this case, the term-sheet of the trade, through its CSA - uncleared trades - or rule book - cleared trades -, is altered and the pay-offs, at least the ones associated to the payment of interest on the VM are changed. That change of term-sheet requires a compensation.

In the uncleared work, the compensation scheme has to be agreed by both counterparties to the trade. In the CCP world, the clearing house is the calculation agent and they may have the right to do the change at their own conditions, but there is still an expectation that this will be done in a fair way for each participant. The compensation for the change of collateral rate is not a standard variation margin for which the exact formula has a small impact; this is a fundamental transfer of value. It has to be computed very precisely and is a definitive value transfer.

The change is composed of two parts: The change of level between the two rates and the specific details of the rate on each day. Historically the difference between SOFR and EFFR has been a couple of basis point on average, with SOFR higher than EFFR. That difference is reflected into the basis swap for SOFR v EFFR. The change due to daily idiosyncrasies and intra-month seasonality is more complex. The quoted rate are for monthly or even yearly periods; the liquid market does not provide information about single days. Moreover, a good forward curve should replicate the shape of historical data with steps between FOMC meetings and on top the intra-month seasonality for SOFR.

In this note we concentrate on the intra-month seasonality. We suppose that the difference of average level has been taken into account and does not need to be look at anymore.

Methods to incorporate the seasonality in the curve was described our recent blog Fed Funds to SOFR: Impact of seasonality. In this blog we look at the monetary impact of that seasonality. By definition, on average the impact is null. But that impact will be spread between the different parties in a different way and some parties may be advantaged by the methodology selected. Some parties may position themselves in such a way to take advantage of the transfer.

Historically the SOFR rates have been higher on month end, in the first days of the month and around the 15th of the month. We create positions with a total PV01 equal 0 but with an impact on the value due to expected idiosyncratic spikes. The impact on value is estimated by valuing the portfolios with one forward curve including the seasonality and one without seasonality.The seasonality we use for this analysis is the one we have described in the previous blog.

The exact mechanism is the following: we create two swaps, one with a maturity date on the last day of the month and one with a maturity on the first day of the month or shortly after. The first swap has a given notional (1 billion) and the second one has a notional slightly adapted to have the exact same total PV01 on the discounting curve.

The first example has a 6 month tenor and a fixed rate of 2.50% (not too far away from ATM). The swap is fixed semi-bond versus LIBOR-3M quarterly. The total PV01 for the discounting is by construction 0.00 USD. The total impact of the seasonality is 4.23 USD. From a pure PV01 comparison perspective, it seems that the change of discounting curve should not have any impact on the value but we still see some impact even if restricted. The bucketed PV01 is provided in Figure 1.

Figure 1. Bucketed PV01 of a short swap.

We could also have selected to have a total PV01 of 0 (not the discounting one equal to 0) or even all of them equal to 0 by adding small ATM swaps at each maturity. The results would not have been altered significantly.

In the second example, we look at a longer swap with a tenor of 2Y and a coupon of 10%. it represents the end of a long term swap that was traded some years ago when the rates were significantly higher than today. The maturities are 31-Jan-2021 and 5-Feb-2021. The bucketed PV01 is provided in Figure 2. Again the total PV01 for the discounting curve is 0. In this case the impact of seasonality is USD 1,842.38. Again that may look small but this is out of a PV01 of 0 for which the expected impact would have been close to 0.

Figure 2. Bucketed PV01 of a 2-year swap with a large fixed coupon.

We could have increased that impact by taking longer maturity swaps or focusing on end-of-year impacts. Note that the 1-Jan-2021 is a Friday and the end of year will be on a 4-day period. If we take a pair of zero-coupon swaps traded at the end of 2007/beginning of 2008 and ending one week apart around the end of 2020, we obtain a difference larger than USD 7,000. This was obtained with a end-of-month average spike of 13.5bps. If we were to use last year end-of-year spike which was above 60 bps for a couple of days, we would obtain impact larger than USD 30,000.

The amount above were obtain with a notional of 2 billions (1 billion in each direction). Given that the total outstanding amount at LCH is 150 trillions, the theoretical potential impact on valuation of the seasonality could be above 100 millions if the feature of dates of the second example was representative of the composition of the CCP book.

What is the impact of seasonal adjustment on your book? Do you have tools to incorporate the seasonality in your valuation mechanism and check if the proposed compensation for change of collateral/discounting is a fair compensation for your own book?

Don't hesitate to contact us to discuss how we can help in this process.

Sunday, 23 June 2019

Fed Funds to SOFR: Impact of seasonality

The USD market is in transition between Effective Fed Fund Rates (EFFR) and Secured Overnight Financing Rate (SOFR) as the main overnight benchmark.

Once the transition will be completed, the main source of liquidity for OIS will be based on SOFR. For the OIS transition, the change will be gradual. The new OIS trades will be more and more linked to SOFR, but the legacy trade already entered into and linked to EFFR will not be directly affected.

Currently, the EFFR is not only used as the underlying for OIS but also, and maybe more importantly, used as the reference rate for the payment of interest on the Variation Margin (VM). The rate for VM is usually described in a CSA (non-cleared) or the house rule book (cleared). For the usage of the overnight benchmark in collateral, it is expected that the transition will be more "brutal". For example, LCH and CME have announced that they plan to switch from EFFR to SOFR at some stage in 2020. The switch will be done on one day, without gradual transition and without possibility for the members to switch from one to the other at their own pace.

The change of collateral rate impacts the present value of all the trades through the discounting. The exact details of the collateral discounting approach can be found in (Henrard 2014, Chapter 8). The collateral rate is part of the term-sheet of the trade (through the CSA or the rule book) and a change of term-sheet must be compensated in some way. To estimate the compensation, you need two ingredients: the difference of average between the two rates and the difference of "local behavior". In the case of EFFR v SOFR the difference of local behavior is the intra-month seasonality. As can be seen in Figure 1, the SOFR rate, based on a wider market, has some very clear seasonal behavior. In particular, one can see sharp rate increases at month-end that subside for a couple of days and some sharp increase around the 15th of the month, even if to a lesser extend.

Figure 1: Historical data comparison between EFFR and SOFR (most recent data missing due to issue with the Fed website).

In this blog we will look at the seasonal adjustment and how it can be incorporated in the curve calibration. In a forthcoming blog, we will look at the impact of the seasonality on the valuation.

The first step of this intra-month seasonality analysis is to quantify it. For this we used the historical data, which is now a little bit longer than one year, and estimated a couple of effects. We use a relatively simple method. We split the month is 6 parts: First business day of the month, second business of the month, the day starting on the first business day on or after the 15th, the second lasst business day of the month, the last business day of the month and the rest of the month. For each of this parts, we estimate the difference between EFFR and SOFR since the publication of SOFR. The results we obtained are provided in Table 1. One can see that the seasonal effect is significant with the month end reaching 13.5 bps above average, the peak subside over a couple of days (8 bps and then 4.5 bps) and a second, smaller, peak appear on the 15th of the month with a level of 4 bps. We have not found any specific impact on the second last day of the month. We do not claim that this is the best way to estimate the intra-month seasonality; each firm will have his own approach(es). We use those simplified number as an example of the impact on curve calibration

Description Spread EFFR-SOFR (bps) Adjusted to other Adjusted to average
First 10.4 9.3 8.0
Second 7.0 5.9 4.6
15th 6.3 5.2 3.9
Second last 0.9 -0.2 -1.5
Last 15.9 14.8 13.5
Other 1.1 - -1.3
Average 2.4 - -

Table 1: Average of specific intra-month seasonality.

How to incorporate this information in the curve calibration? Obviously the curve after calibration should match the market exactly, so it is not a valid method to calibrate the curve with you favorite method and then to manipulate the result to incorporate those seasonality. After the manipulation, the curve would not match the market perfectly anymore. The seasonality has to be incorporated in the calibration step.

For the calibration presented here, we used OpenGamma's Strata library as the starting point. The library is very flexible in term of curve calibration and it is easy to extend and incorporate your own curve mechanism in it.

We have added a new type of curve. It consist of a "fixed curve", in which we incorporate the seasonality, and a variable main part. The two parts put together form a unique curve. We call the first curve fixed as we have created it from our historical data analysis and it will not be changed in the calibration procedure. The variable part is the one that will be calibrated.  Just to reiterate, we have one curve, which internally is divided in two parts, and we calibrate that one curve to the market. There will be no adjustment after the calibration. The one step calibration include both the general shape and the seasonal adjustment.

To match the usual shape of the overnight rate behavior, the main curve is interpolated using log-linear interpolation on the discount factors with node on the FOMC date. In that way the overnight forward rates follow a piecewise constant shape with jumps at the FOMC meeting dates (see Henrard 2014, Chapter 5 for the details).

We did the calibration described above with and without adjustment for seasonality. The calibration was done with market data from 21-Jun-2019. The non-adjusted curve is presented in Figure 2 and the adjusted one is added in Figure 3. Figure 4 depict the difference between the two.

Figure 2: Forward overnight rates implied by the curve calibration without adjustment to intra-month seasonality.

Figure 3: Forward overnight rates implied by the curve calibration with adjustment to intra-month seasonality.

Figure 4: Spread of forward overnight rates implied by the curve calibration with and without adjustment to intra-month seasonality.

In the difference one can see clearly the month-end and first days of the month impact and also the 15th of the month impact. Even if the above impacts have a fixed amplitude, the impact on the other part is not always the same. The reason is that the length of the months are different and in some cases, some of the dates above span a three calendar days period instead of one.

The code will be added to the muRisQ-ir-models open source library at a later stage.

Henrard, M. (2014). Interest Rate Modelling in the Multi-curve Framework: Foundations, Evolution and Implementation. Applied Quantitative Finance. Palgrave Macmillan. ISBN: 978-1-137-37465-3.

Wednesday, 12 June 2019

Is the LIBOR/SONIA spread curve flat?

In a recent blog we described the apparent convergence of the market basis spread to historical spot averages. This would be a consequence of the new fallback language based on historical mean/median. To illustrate this we have used USD 30Y EFFR/LIBOR basis swaps data and previously GBP 30Y SONIA/LIBOR basis swaps.

An argument that we have heard against our description of this convergence is that the spread curve is not flat. The argument is that if there was a convergence to historical mean, it should be the same for all tenors and the curve should be completely flat. If you look at the curve as of the end of May, you can see that the curve is not flat at all; the spreads are between 9 and 17 basis points. The graph of the GBP SONIA/LIBOR-3M basis spread for different tenors is displayed in Figure 1.

Figure 1: Shape of the GBP SONIA/LIBOR-3M basis spread curve as of 24 May 2019

Our answer is the following: The argument is correct but incorrectly applied. Yes, if the market has already incorporated the fallback on an average spread, the spread should be the same for all tenors and the curve should be very flat. But this argument applies only for swaps after the discontinuation date. The discontinuation is expected to take place at the start of 2022.

Now we can look at the same data with the correct glasses. What are the spreads for basis swaps starting somewhere after 2022 and with different tenors? We have not looked only at starts in 2022, but at forward starts with starting dates every 6 months for the next six years. The results are displayed in Figure 2.

Figure 2. Shape of the GBP SONIA/LIBOR-3M basis spread curve and several forward starting curves as of 24 May 2019

From that figure we can see two things. 1) the curve is (almost) flat for forward swaps starting after 2022. 2) The curves are not flat for swap starting in the next 18 months.

Not only is the market really pricing a flat curve in line with the convergence arguments but we can also infer that the market is not expecting a discontinuation in the next 18 months. The shape of the curve seems more an evidence for the convergence as described in previous blogs than against it.