Sunday, 21 October 2018

LIBOR Fallback transformers!

In our quant perspective on IBOR fallback, we discuss the quantitative finance aspect of the fallback and its different options, even adding some options to the ones proposed by ISDA.

Once the theoretical side is done, we can move to the practical side. What would happen, not to a single payment and its detailed dates and convexity adjustment, but to a large portfolio? Portfolios a composed of hundred, thousand or even tens of thousand of swaps with many offsets. How do we estimate the impacts of the fallback when the trades' term sheet is transformed by it? Is there a quant solution to quickly analyze the fallback impacts?

This is not anymore a simple single curve to multi-curve problem. What we witnessed in 2008 by the move from single curve (LIBOR discounting) to multi-curve (OIS discounting) is very small with respect to fallback. In the multi-curve issue, it was simply the valuation estimate that was changed on a trade that remained unchanged. Here we have the trade itself - and obviously its valuation estimate - that changes.

Moreover, most of the ISDA proposed fallbacks lead to non-standard trades of which you probably don't have a single instance in you current portfolios - this is the case for option 1, 2 and 4. You have to transform the trades, in a different way for each option, and apply valuation method on each of them. Not a standard task for quants and risk managers. Your trades may be stored in data bases or systems that do not even support those new term sheets.  In theory, this is not very difficult, in practice this could be a lot of work especially that only one of the fallback options will be actually implemented, so 3/4 of the transformation work will just be thrown away.

As we have been working on the fallback issue since more than 6 months, we have developed a lot of  ideas, formulas, code and insight into the problem. In particular we have created a

Fallback Transformer.

The idea is that you pass your portfolio of legacy swaps, they are transformed into different version associated to the fallback options and for each option valuation and risks are computed in a flexible way. Depending of the hypothesis on the spread adjustment, the pricing mechanism and the curves, you can easily have 10 versions of the fallback's impact. It will not tell you exactly how to solve all your issues, but it will allow you to be

Ready for the fallback.

We will describe some extracts of the transformer results in forthcoming blogs.

The first part (to be published later today) describes the present value and (delta) risk of a single trade for the different options. The second part describes the valuation impact on a large portfolio and the computation performance. In the third part, we we look at the convexity adjustments.


  1. Fallback transformers - Introduction
  2. Fallback transformers - Present value and delta
  3. Fallback transformers - Portfolio valuation
  4. Fallback transformers - Forward discontinuation
  5. Fallback transformers - Convexity adjustments
  6. Fallback transformers - magnified view on risk
  7. Fallback transformers - Risk transition


Don't fallback, step forward!

Contact us for our LIBOR fallback quant solutions.