US -- Eurodollar futures a USD 8 million rounding error

Last week, Marc presented a workshop on the ”LIBOR transition: What could we have done better from a quantitative perspective?” at the CEETA Benchmark Congress in Warsaw.

Among the elements presented were the results of the fallback on euro-dollar futures at CME that were converted to SOFR futures. An interesting issue with the conversion is the number of decimals. The conversion was done using the ISDA/Bloomberg designed spread between USD-LIBOR-3M and the replacement SOFR of 26.161 bps. This is a number in basis points with three decimals. But the futures are quoted with only 0.5 basis point precision. A natural question is what happen to the extrta decimals? Simply it created a profit for those who understood it.

In the conversion, roughly 4 millions LIBOR futures were converted to SOFR futures, but the open interests in SOFR futures were almost unchanged. The 4 millions futures did not simply disappear, there were offsetting positions between the LIBOR and SOFR futures that had cancelling effects on the next day. The offsets were not between different market participants, but for the same participant having offsetting positions between LIBOR and SOFR futures. The spread between the two was known since 5 March 2021. The amount involved is 4,000,000 contracts with USD 1,000,000 notional each, this means USD 4,000,000,000,000 (4 trillions), not a notional resulting from an ignorant retail trader!

The closing price for the different futures on 14 April 2023 (the conversion date) were:

Closing prices	Sep 23	Dec 23	Mar 24
ED	94.965	95.33	95.785
SR3	95.225	95.59	96.045
Spread (bps)	26	26	26

Take the strategy to buy SR3 at 95.225 and Sell ED at 94.965. The next day, the position is Long SR3 at 95.225 and Short SR3 at 95.22626. The total P/L is, irrespective of the price the next day: (P - 95.225) - (P - 95.22661) = 0.00161%.

The impact of rounding is (number of contracts x notional / basis points / quarterly / offsets * spread)

4,000,000 x 1,000,000 / 10,000 / 4 / 2 * 0.161 ~ 8,000,000

The rounding had an impact of USD 8,000,000.

Given that the spread is known since March 2021, one can guess that market makers have used any opportunity in the last 2 years to add ofsseting positions each time the tradable spread moved away from the 26.161 basis point. The actual arbitrage from the conversion is probbaly well above the figure indicated above.

Hopefully our readers were on the profitable side of the arbitrage.

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Don't hesitate to contact us if you require advisory services related to the benchmark transitions.

Publication: LIBOR: le chiffre le plus important du monde disparaît

Marc a publié un article de vulgarisation sur la disparition du LIBOR dans le magazine EcoFin Mag (ECOFINMAR n 15 - mars 2023, page 32). L’article est intitulé

LIBOR: le chiffre le plus important du monde disparaît.

Une copie de l’article peut être obtenue ici.

Swap Rates and Term Structure Modelling: Implementation note published

The implementation note related to the Swap Rates and Term Structure Modelling described in one of our previous post has now been published on SSRN.

The note is available as a muRis_Q Advisory Implementation Notes:

Swap Rates and Term Structure Modelling

The paper is available on SSRN

https://ssrn.com/abstract=4438524.

Abstract

WThis document contains implementation notes related to Bang and Daboussi (2022). We have extended the original paper by allowing actual accrual factors (not all 1) and non-annual frequency on the fixed side. The note first describes the detailed formulas in this extended setting. In a second part some choices of the implementation and results obtained are provided.

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Don't hesitate to contact us if you require advisory services related to interest rate modelling.

CEETA Benchmark Congress

Marc will present at the Benchmark Congress organised by CEETA in Warsaw 15-16 May. Most of the congress will be held in Polish and focus on the WIBOR transistion.

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Marc's presentation will be divided in two parts

SOFR - USD LIBOR transition: where do we stand?

and

LIBOR transition: what could we have done better from a quantitative perspective.

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Don't hesitate to contact us if you require advisory related to the benchmark transitions.

CCP Basis - Large LCH-EUREX basis - not unexpected

On Thursday and Friday, Marc was presenting a workshop on “multi-curve and collateral framework and IBOR transition”.

Among the slides presented was this one:

This is a back-of-envelop computation of IM funding cost (Margin Value Adjustment - MLA) to take advantage of the CCP basis. This computation leads to a 1.5 bps annualized at each CCP, i.e. 3.0 bps total. The slide was presented with a graph of the recent LCH-EUREX basis in EUR done a couple of days before and showing the peak at 4 bps for the 10 year.

The same day that the slide was presented, the following article was published in Risk:

Eurex-LCH basis hits new highs amid rates vol

This shows that the basis, which looks like an arbitrage, is very difficult to monetize, that 4 bps may not be a strong anomaly but just a feature of the market and that constraints on the market by regulators may have unintended, but not unexpected consequences.

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Don't hesitate to contact us if you are interested by independent advise related to market infrastructures, initial margins and interest rate markets.

SOFR First, the next (but not yet final) step!

The USD interest rate derivative market has reached the next "SOFR First"!

We need to qualify that statement. There are many ways to measure what "SOFR First" means. The first "SOFR First" initiative date from July 2021 and consisting of the regulators saying "please use SOFR". Then there were plenty of informal SOFR First

• the first day/week where there were more notional on SOFR OTC transactions  than LIBOR transactions,
• when SOFR transactions represented more than 50% of the IR OTC derivative market, 
• the last date/week when notional on LIBOR transactions was higher than SOFR transactions
• the first day/week where there were more notional on SOFR ETD/futures transactions than LIBOR transactions,
• etc.

Now it seems we have reached the next "SOFR First" moment (see Figure 1):

the outstanding notional on SOFR-linked derivatives at LCH is higher than the outstanding notional on LIBOR-linked derivatives

Note that we have not reached yet the moment when the outstanding notional on SOFR-linked derivatives at LCH is more than 50% outstanding notional on LIBOR-linked derivatives. We have not reached yet the moment when SOFR is more than 50% of derivative every week. For the moment, EFFR is still above SOFR on a regular basis (see Figure 2).

That moment will come, but it is not clear yet if it will come before the LIBOR transactions are mandatory converted to SOFR.

Figure 1: Outstanding amounts by benchmarks at LCH

Figure 2: Weekly share by product types at LCH

Figure 3: Weekly SOFR volume at LCH and as reported by ISDA (US regulatory figures based).

Workshop multi-curve - Warsaw 23-24 March

Marc will be presenting a two-day workshop on the”multi-curve and collateral framework and IBOR transition”. The workshop is organised by CEETA in Warsaw on 23-24 March.

The program is similar to Marc's typical Multi-curve and collateral framework: foundations, evolution and implementation with recent updates on the IBOR transition. The specific program is available on LinkedIn at https://www.linkedin.com/posts/tomaszdendura_multi-curve-collateral-framework-by-henrard-activity-7029797799818870784-C5g8/

You can contact the organizer Tomasz Dendura for the practical details.

USD rate benchmarks 7 weeks in 2023

We are now 7 weeks into 2023. Where do we stand in term of USD rate benchmarks?

LIBOR volume continue to decrease significantly. At LCH, it represent less than 30% on a weekly basis with the last two weeks even below 10%.

As reported in our recent post on USD Benchmarks: the winner for 2022 is ... Fed Funds!, Fed Funds dominate the USD landscape in nominal terms — not in DV01 weighted terms.

Figure 1: Weekly share by product types at LCH

If we look at the oputstanding amounts, the order has not changed for a year or so, with in decreasing order LIBOR-SOFR-EFFR. SOFR is closing the gap to LIBOR; LIBOR is around USD 60 trn down from more than USD 80 trn while SOFR is up to more than USD 55 trn from less than USD 20 trn a year ago. EFFR is around USD 25 trn. It seems that we approaching the date where SOFR will be above LIBOR. That date will be the final "SOFR First" date.

Figure 2: Outstanding amounts by benchmarks at LCH

We can compare the USD-SOFR derivartive volume to GBP-SONIA and EUR-ESTR. Obviously they are in different currencies and GBP and EUR attrach significantly less derivative volume in general. But the comparison is interesting as the difference in volume terms in not large. ESTR is even above SOFR in most of the weeks, except the last two weeks. For GBP, SONIA is the only significant benchmark. For EUR, there is still EURIBOR, without plan to stop it and ESTR as unique overnight benchmark. In USD, the situation is more complex with USD-LIBOR that is planned to stop in June 2023, and two liquid overnight benchmarks EFFR and SOFR — plus other less liquid benchmarks like AMERIBOR and BSBY.

Figure 3: Comparison between volume of GBP-SONIA, USD-SOFR and EUR-ESTR at LCH.

This shows that there is still some room before SOFR becomes the really dominant benchmark in USD rate derivatives.

USD Benchmarks: the winner for 2022 is ... Fed Funds!

For the first post of the new year, we have been looking at the volume traded on LCH for 2022. In notional terms, we get a maybe unexpected benchmark winner: Effective Fed Funds Rates (EFFR). For the last couple of years, the discussion has been all around LIBOR v SOFR but somehow EFFR manage to emerge as the winner. For the year 2022, the results are EFFR 37.6%, SOFR 33.3% and LIBOR 29.2% (we ignored inflation, basis swaps and VNS for the above shares). The weekly figures for the year are provided in Figure 1.

Figure 1: Weekly share by product types at LCH

The figure used are in pure notional terms, not risk/PV01 weighted. On a risk weighted scale, the results would probably be different - the LCH risk weighted figure are not publicly available to our knowledge.

LIBOR trading almost disappeared in last week of the year to show the smallest share ever.

On an outstanding volume, the picture is very different. SOFR has increased on a regular basis and EFFR and LIBOR have trended downward. LIBOR has still the larger share in outstanding volume with around USD 60.4 trn, then comes SOFR with USD 47.7 trn and finally EFFR with 7.6 trn. The graph with the outstanding amounts is provided in Figure 2. (1) There was probably some compression activity close to year end as all outstanding volumes were down. Overall, the outstanding amount for LIBOR has been only done 25% (USD 80 to 60 trn), which sounds like a small decrease giving the expected LIBOR's disappearance in 6 months time.

Figure 2: Outstanding amounts by benchmarks at LCH

Figure 3: Weekly SOFR volume at LCH and as reported by ISDA (US regulatory figures based).

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(1) Note that our outstanding amount graphs for EFFR were incorrect in some of our previous blogs. The latest values in each graph was correct but not the past values.

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Added 2023-02-01: Following our blog, Clarus publish a complementary blog adding DV01 based figures. The post is available at https://www.clarusft.com/are-fed-funds-the-latest-winner-from-benchmark-reform/. They confirmed our finding on a pure volume basis. On a DVO1 weighted basis, the picture is very different with SOFR dominating EFFR. Note also that on a DV01 weighted basis, the highest SOFR volume was in March 2022 and the trend has been slightly downward since.

LIBOR transition: approaching year end

We are approaching year end. One last "weekly" review before the yearly review next week. We have not been fully consistent with our weekly updates recently, but to our defense, there have not been huge changes in the weekly patterns.

The share between LIBOR, EFFR and SOFR are changing every week, but none of them is reaching 50%. So no real LIBOR, EFFR or SOFR first. The LIBOR share is decreasing but still significant.

Figure 1: Weekly share by product types at LCH

The LCH figures and ISDA figures (based on US regulatory filling) are saying basically the same thing. The trend is in the increase of SOFR and decrease of LIBOR, but it is not a smooth trend. No major change in the last 9 months.

Figure 2: Weekly SOFR volume at LCH and as reported by ISDA (US regulatory figures based).

From an outstanding notional point of view, LIBOR is decreasing, SOFR is strongly increasing and EFFR is slightly increasing. We are still more than 10 trillions away from SOFR First.

Figure 3: Outstanding amounts by benchmarks at LCH