Wednesday, 13 October 2021

ICE Swap Rate fallback: impact on swaption pricing

Sterling and dollar working groups have proposed fallback for ICE Swap Rates (ISR) based on the mechanism used for LIBOR itself. It is not possible to create a ISR's fallback coherent with the LIBOR's fallback. Or more precisely it is possible (and easy) for a quant to do so, based on the swap market globally, but it is impossible for a lawyer in a definition involving only one number published on a single screen.

The self-imposed restriction on the type of fallback available make the existence of a coherent fallback impossible. In the absence of an exactly coherent fallback, the working groups tried to provide an approximately coherent one.

The impacts of those fallback go beyond simply printing a formula on a piece of paper and have profound impacts on the valuation and risk management of existing instruments like swaptions.

In particular cash settled swaptions with collateral discounting have a triple problem:

  • Incoherent spread (delta hedge with swaps)
  • Non linear pay-off
  • ``Non-natural'' annuity, i.e. convexity adjustment

The incoherent spread was discussed by Marc in a previous blog: LIBOR transition: How to lose money, automatically!

In a forthcoming paper, we will show how those swaptions can be priced.

The one line summary of the pricing method is a change of strike in line with the non-linear rate transformation and a replication similar to the one used in CMS pricing.

Some early results have been presented in LIBOR transition workshops. A more detailed seminar related to the swaption pricing will be presented at The WBS 17th Quantitative Finance Conference.

Below we already proposed a graph that displays the non-linearity impact, the exact meaning of which will be discussed in the seminar. We will post a link to the full paper once published.


Note added 20 October 2021: A preliminary version of the results were presented at The 4th Interest Rate Reform Conference today.

Note added 20 October 2021: I have added the ICE Swap Rate fallback formulas to my open source library muRisQ-ir-models at https://github.com/marc-henrard/muRisQ-ir-models/blob/master/src/main/java/marc/henrard/murisq/pricer/generic/FallbackIsrUtils.java.

SOFR volume to 8 October 2021

Usual review of SOFR volumes. After a small increase a couple of weeks ago that lead us to ask "Is something happening?", we are back to levels below mid-July level at LCH. ISDA figures indicate that SOFR is back to less than 10% of interest rate derivatives volume.

No real progress a little bit more than two months before the expected deadline for "no more LIBOR".

Short term swaps (less than 2Y) volume is not increasing either, which is not a good indication for the development of Term SOFR rates.

Tuesday, 28 September 2021

SOFR: Is something happening?

Weekly volumes of interest rate trades. Is SOFR slowly waking-up? Weekly volume last week are the highest ever, higher than mid-July. ISDA reported figures (US only) have the highest percentage of SOFR outright volume (almost 14%).

The ISDA data (representing data reported to US regulators) is growing faster than the LCH data (international markets). Does it means that international users are slower to move to SOFR and that we could have two markets: a local market (with local regulatory pressure) and an international market (with more market freedom)?

Note that we have change the definition of relative portion in the graph. The outright SOFR is now reported as portion of all trades, not portion of LIBOR trades. This is to avoid "infinite" results when LIBOR will disappear. The portion is now capped at 100%.

Tuesday, 21 September 2021

SOFR first - two months on

Presented without comments this week.

Comments on ESTR, SARON, and SOFR to come later!

Tuesday, 14 September 2021

Decrease in SOFR activity

We are not certain of its origin, but certainly a significant decrease in SOFR activity last week. The lowest in the "SOFR First" era at LCH and lowest in 5 weeks for the ISDA reported figures. But the ISDA reported figures indicated a relative increase with respect to LIBOR.

It is not clear what the origin of this is. One potential explanation is market moving out of LIBOR but not to SOFR.

CME futures on BSBY provide a view of market price discovery of SOFR v credit sensitive rates. For those that have not yet agreed on the fallback for legacy LIBOR trades, that opens a window on valuation impacts.

This makes Marc's cautionary tale published in January 2020 edition of Risk even more tangible. It is now possible, to some extend, to measure the exercise value of the protocol option. Marc mentioned the "Fallback protocol as an option" in the past, in particular in the blog "ISDA Fallback as an option".

For the (low volume for BSBY and SOFR) trades on the September 2023 contract (first after USD-LIBOR cessation), the spread LIBOR-SOFR is 27 bps and the spread BSBY-SOFR is 19 bps. The first one is roughly in line with the CME Eurodollar futures fallback using ISDA/Bloomberg spread (26.161 bps), the second one provides the cost of protocol signature for a September 2023 fixing: losing or making 8 bps. Lets wait for more volume on the longer term part to assess more of the value transfer. We will try to provide more data on BSBY in a forthcoming blog.

Wednesday, 8 September 2021

SOFR first - six weeks on

No big push since "SOFR First" date six weeks ago. Quite flat volume, both on the weekly figures and on the monthly figures. Using ISDA figures, SOFR outright OIS volumes still less than 10% of LIBOR volumes.

Workshops with CQF insitute

Marc Henrard will present two workshop with the CQF insiture.


The first one will take place on Wednesday 6 and Thursday 7 October 2021.


The second one will take place on Tuesday 9 and Wednesday 10 November 2021.


The agendas of the workshops can be found on the webpages references above.


Don't hesitate to contact us if you want to organise similar workshops in-house.

Tuesday, 31 August 2021

SOFR first - five weeks on

No big push since "SOFR First" date five weeks ago. Using ISDA figures, SOFR outright OIS volumes still less than 10% of LIBOR volumes.

Wednesday, 25 August 2021

SGD SORA figures

On popular demand, we also publish some SGD SORA figures. 

Figure 1. Monthly figures (to July 2021) for SORA clearing at LCH.

Figure 2. Weekly figures (to 20 August 2021) for SORA clearing at LCH.

Tuesday, 24 August 2021

Workshop at the 4th Interest Rate Reform Conference - 19 October 2021

 

Marc Henrard will present a workshop at

The 4th Interest Rate Reform (Ibor Transition) Conference

which will take place on-line from Tuesday 19 to Thursday 21 October 2021. The agenda of the conference can be found on the organizer web site:




Marc's workshop will take place on Tuesday 19 October from 13:00 to 17:00 and will be titled  

LIBOR transition: almost there and so much to do for quants.

Agenda:

  • Liquidity in ESTR, SONIA and SOFR
  • Multiple fallbacks, multiple market risks, one spread to rule them all!
  • ISDA fallback spreads v recent LIBOR/SOFR data
  • USD: alternatives to SOFR - AMERIBOR, BSBY, ICE BYI, AXI, CMT
  • Hidden issues