Tuesday, 5 July 2022

LIBOR Transition: Back to "LIBOR First"

For the first time in a while, we are back to "LIBOR First" at LCH and for US regulatory figures.

Figure 1: Weekly share by product types at LCH

The story told by the ISDA published US regulatory figures is similar (see Figure 2). For those figures also, LIBOR is back to the fore. This can be seen with the ratio SOFR outright/(LIBOR+SOFR) which is back below 50%.

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

There are more and more discussion about allowing a wider use of the SOFR Term rate. This is based on its usage in cash products. Derivatives are (or at least should be) designed to help risk management. If derivatives cannot be based on the same underlying benchmark as the cash product, they become less useful. This is the case for Term Rate based swaps but also optional products like cap/floor. Some cash products have explicit or implicit cap or floor, but currently they cannot be hedged easily in the wholesale market.

Issues regarding the SOFR Term rate itself can also been seen in Figure 2. The short term part of the SOFR-OIS (less than 2 year) is not large. This means that it is difficult to established a term rate based on liquid regulated electronic trading venues (Level 1 waterfall). We have mentioned this issue in several blogs and presentation (see here for example). Currently, CME SOFR Term rate is based on level 3 of the waterfall (futures) and IBA SOFR Term rate is based on level 2 of the waterfall (dealer to client). Also when using futures, creating the term rate requires some arbitrary interpolation scheme choice and has some timing issue.

With only one year to go to the LIBOR end date, this is not very good for the transition!