Monday, 23 May 2022

LIBOR: Large OTC volume! SOFR: Large ETD volume!

Big increase in LIBOR OTC swaps volume this week!

Figure 1: Weekly share by product types at LCH

But on the futures side, we had, for the first time, a couple of "SOFR First" days last week from a volume perspective. The volume of SOFR-3M futures has been above the volume of LIBOR-3M futures from Wednesday to Friday (see Figure 2). The SOFR First is only in terms of volume, not in terms of open interest. In OI terms, SOFR-3M futures represent 50% of LIBOR-3M. Actually the 50% treshold was reached on Tuesday 24 May and now stands at 50.02%!

Figure 2: Daily STIR futures volume at CME.

The open interest for LIBOR-3M futures is decreasing very slowly. Since 31 December, the OI has decrease only by 7.2%. Note also that the total volume (SOFR+LIBOR) is significantly lower than previous peaks. It is not clear if this is structural or conjectural. But with uncertainty about monetary policy path, one could have expected a larger volume.

New published paper: Swap Rate fallback: unreasonable effectiveness of approximations and alternatives

A couple of months ago, we announced that the research paper written by Marc and titled

Swap Rate: cash settled swaptions in the fallback

had been accepted for publication in Risk. The article will appear in the June edition.

Since, that research has been deepened and we are pleased to announce that the follow-up article has been already accepted for publication in Wilmott Magazine. The article is titled

Swap Rate fallback: unreasonable effectiveness of approximations and alternatives.


Cash-settled swaptions with collateral discounting are impacted by the Swap Rate fallback mechanisms decided by working groups/ISDA. The legacy vanilla swaptions are becoming exotic products, as the mechanism is based on a non-linear transformation of the OIS swap rate, and generate convexity adjustments. It turns out that those two effects almost cancel each other and lead to almost vanilla products. We analyse those cancelling effects and the risk management impacts. Based on those insights, we propose an adjusted fallback mechanism that reduces further the exotic features and simplify further the risk management of the legacy book.

The article should be published in the September issue. 

As a teaser, the graph below describes by which factor the "exoticness" of the fallback is reduced by our proposed alternative mechanism for different market movements. All the technical details are available in the paper.

Figure 1: Reduction in "exoticness" achieved by the alternative fallback proposal.

Don't hesitate to contact us if you are interested by the alternative to the ISDA fallback for swap rates. Cash settled swaption fallback can be a lot simpler than the current approach. Why not simplify your transition risk at no cost?

Tuesday, 17 May 2022

LIBOR-SOFR transition - still many unknowns

We start this week with a LCH consultation regarding the Conversion of Outstanding Cleared USD LIBOR Contracts. No big surprise in the content of the consultation itself. It is roughly the same a proposal for USD in June 2023 than the one for GBP in December 2021.

But this consultation is also the occasion to remember the uncertainty surrounding cleared LIBOR trades, the OTC versions at LCH and CME but also the ETD futures versions at CME. Each trade involving a LIBOR fixing beyond June 2023 need a precise fallback. The cleared trades don't have a precise fallback yet. The existence of the consultation, almost 5 years after the "Future of LIBOR" speech, is a reminder that the transition is still unplanned. The figures below illustrate that LIBOR still attracts more volume than SOFR. But a lot of those LIBOR-linked trade are for an unknown term sheet. 

The cleared swaps term sheet can be modified unilaterally by the CCPs using unknown mechanisms. The LIBOR futures will be transformed into SOFR futures at an unknown date and with unknown mechanisms. Yes, those mechanisms have been roughly described and there is an expectation that there will be little modification of them. But remember, for the ISDA definition, there was a consultation and then after the results were announced, the actual meaning of the different fallback mechanism was decided by Bloomberg! For cleared GBP swap at LCH, it was announced that the ISDA mechanism would be copied, only to decide later that a different mechanism would be used.

As model validators, we don't understand how the trading of Eurodollar futures or cleared LIBOR swaps can be validated from a quant perspective when the exact term sheet is still unknown.

Coming back to our weekly statistics, we see that at LCH, from a volume perspective, SOFR is still third. Five months into 2022, we certainly have not achieved "SOFR First" in a stable way.

Figure 1: Weekly share by product types at LCH

Last week, the SOFR relative volume was around 29.0%. It has been lower than both the LIBOR and the EFFR volumes for several weeks now. On an absolute basis, the volume has not been increasing either. Last week volumes at LCH and as reported by ISDA are lower than the one reported in February as displayed in Figure 2.

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

The futures do not paint a very different picture. The volume of LIBOR-3M futures is still above the volume of SOFR-3M futures each and every day, as displayed in Figure 3.

Figure 3: Daily futures volume at CME.

The activity in LIBOR futures is certainly not all risk reducing as regulators would like. Since the beginning of the year almost 222 million LIBOR futures contract have been traded. Over the same period, the open interest in the same futures has decreased by a pale 660,000 contracts. A maximum of 0.3% of the trades are risk reducing. We say "maximum" as a certain amount of trades expired on a monthly basis — we don't have the expiry figures so cannot adjust the above figure.

Tuesday, 10 May 2022

SOFR still third and other RFR's volume decreasing

For the second week in a row, SOFR is coming third in the benchmark race at LCH. Its share is down to 27.4%.

Figure 1: Weekly share by product types at LCH

On an absolute basis, the SOFR figures are not great either. The weekly traded notional was around 2.3 trn, which is a level similar to January. The volume has peaked at 3.2 trn at the beginning of April. The SOFR volume decrease is also visible in the ISDA/US regulatory figures.

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

If we look at the currencies for which LIBOR has been discontinued (GBP, JPY and CHF), we see a common behavior for the outstanding amounts at LCH: they are all decreasing since the start of the year (hyphened lines). We don't have a direct explanation. It can be a combination of: better use of compression for overnight, market participants less comfortable with OIS than with IRS, transfer to other CCPs (JSCC for JPY, EUREX for CHF), or something else. But certainly it is worth keeping an eye on it as it seems common to the three currencies.

Figure 3: End of week outstanding notionals at LCH for GBP (SONIA), JPY (TONA) and CHF (SARON).

Wednesday, 4 May 2022

SOFR: one step forward, one step backward.

Just one graph this week.

We are back to "SOFR Third" at LCH!

Figure 1: Weekly share by product types at LCH