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

LIBOR First (where have we seen that before?)

We have not posted on LIBOR transition/SOFR progress for a month, expecting the subject to slowly disappear with the final LIBOR date approaching. But looking at last week data, we have to conclude, once more that we are back to

LIBOR First!

Both in relative terms and in absolute terms, SOFR has not really progressed in the last month. There is more LIBOR volume than SOFR volume. At LCH the LIBOR/SOFR split is 33.9%/30.9% and for ISDA figures (no EFFR figures provided, only outright swaps) it is 53.7%/46.3%. The absolute weekly volume for SOFR is similar to the one of February. The outstanding amounts are stable both for LIBOR and SOFR, SOFR is not catching-up anymore. The LIBOR volume is not risk decreasing. Note that a decent amount of LIBOR activity is probably in single period swaps (SPS, replacing the FRAs due to incoherent LIBOR fallback rules). The data available does not distinguish between the SPS and tenor swaps.

Figure 1: Weekly share by product types at LCH

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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A different perspective on the LIBOR/SOFR data from Clarus: What’s New in Term SOFR?

LIBOR fighting back!

A couple of graphs from last week. It appears that LIBOR is fighting back against SOFR!

From the ISDA figures, SOFR outright is well below LIBOR outright (SOFR around 40% of the market).

Figure 1: Weekly volume for SOFR at LCH and as reported by ISDA (US regulatory figures).

At LCH, the SOFR swaps represented around 36%. Remember ISDA does not report EFFR data and it is based on regulatory figures (notional well below the notional traded at LCH).

Figure 2: Weekly share by product types at LCH

The larger than in the previous weeks LIBOR notional is not linked to cancellations or risk reduction. If anything, the LIBOR outstanding notional has increased over the last weeks.

Figure 3: Outstanding USD derivatives volumes at LCH.

Bond futures delivery option - back to ATM

For a very long times rates on government bonds have been low. In particular they have been low with respect to the “notional rates” used in computing the conversion factors in bond futures.

Those rates were traditionally at 6.00% and are still at that level for US Treasury futures and most of German bonds futures. For the German bonds, the exception is the ultra long bond futures which are based on a 4.00% notional coupon. On the UK Gilt side, most of the notional rates are at 4.00% with the exception of the Short Gilt Futures based on a 3.00% notional coupon.

The recent market movements have brought the UK Gilt rates around 4.00%. Does this matter? What is the impact of the “notional rates” on the behaviour of bond futures?

Bond futures are settled by the physical delivery of a bond. The deliverable bonds are government bonds with a specific maturity range (plus some other conditions on size). The amount paid at delivery for the bond is the futures price multiplied by a “conversion factor” (and the notional). This conversion factor is computed (as a clean price) from the actual bond and from the notional rate. The impact of all this is that the notional rate act as some kind of strike. If the yield is below the notional rate, the shorter maturity bond is usually the cheapest-to-deliver; if the yield is above that rate, the longer maturity bonds is usually cheapest-to-deliver.

They are subtilties around that long/short maturity, in particular dependent on the coupons, as the EUR market has reminded us recently (see  Bund volatility sparks uncertainty around futures delivery).

The delivery option that had been forgotten for a long time is now back in the discussion. A good opportunity to referenced to a more than 15 years old paper by Marc: Bond Futures and Their Options: More than the Cheapest-to-Deliver; Margining and Quality Option (2006).

Obviously, the techniques to analyze this issue have evolved over the last 15 years, and we have implemented several of them. Those proprietary developments are currently not available publicly, but are available to our advisory clients.

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Don't hesitate to contact us if you are interested by modelling embedded options in vanilla products.

Is SOFR first genuinely starting?

"SOFR first" has been mentioned for a long time and was suppose to start in July 2021. There have been many partial achievements along the way. To our opinion, last week was the first time we can mention SOFR First without adding inverted commas around it.

The LCH data indicates that more than 50% of the USD LCH-cleared interest rate derivatives was based on SOFR. Up to now, the achievements had been relative, like "more SOFR than LIBOR". This time, we can really say for the first time "SOFR dominates the USD rate benchmarks".

Figure 1: Weekly share by product types at LCH