Sunday 2 February 2020

Discounting transition: big bang impacts

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.

CCPs are planning a big bang-like collateral and discounting transition for USD. In theory this transition is done with value compensation and risk exchange at fair market value. Such a transition would conduce to the absence of value and risk impact. But by definition of big bang, the transition is done in an illiquid market for which the fair theoretical value is unknown.  To understand the actual impact on valuation and risk, one has to look at the practical details of the transition and how the absence of data for half of the required theoretical quantities is overcome in practice. The resulting situation prompts exotic convexity adjustments for cleared swap and unknown valuation for non-cleared products.

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

Discounting transition: big bang impacts

and is available on SSRN with the reference

Henrard, Marc P. A., Discounting transition: big bang impacts. Market Infrastructure Analysis, muRisQ Advisory, February 2020. Available at SSRN:

Other post related to the discounting transition: Change in collateral rate at CCP: quant perspective.