LIBORS’s losing its lustre
If you aren’t actively preparing for a shift in sterling benchmark, you probably should be. It’s been a year since FCA chief Andrew Bailey gave his original speech on the issue, but he is far from alone now, if you listen or read more recent speeches from Bailey, CFTC Chairman Giancarlo, or the FSB. Their message is clear: change is coming and it’s coming fast (see below for links to recent speeches).
While the pending death of the benchmark is greatly exaggerated, it has definitely passed its heyday. Credit to ICE for doing a great job here as custodian of the benchmark and chief ambassador for LIBOR. The challenge for the money market equivalent of the Luddites, however, is that the economics and risks of continuing to use LIBOR as a benchmark are getting worse. Not only is the cost of providing this data already extremely high, but with participants who use it “Lexit-ing” in increasing numbers, the cost will need to be spread between a smaller number of users. Will the market have different challenges, will the supply and demand equilibrium be disturbed as users migrate from LIBOR based products, will technical issues (switching) drive short term market behaviour?
So, we’re clearly axed: we’re providing a future on the SONIA reference rate – a future that’s cheaper than the equivalent Short Sterling (ICE benchmark referenced product); and it’s free to trade until the end of the year – our bit to help the market transition. That’s our sales pitch.
More importantly, as the volumes fall in unsecured inter-bank lending – and the mandate from the FCA to provide LIBOR rates falls away – can we be sure that the rate won’t change? And what’s the risk impact from a slight curve shift or higher (or lower volatility)? As volumes grow in swaps and futures in non-LIBOR products, supply and market demand changes could erode the industry-wide foundations on which the LIBOR futures market has been built.
Like King Canute, The LIBOR Luddites are doing an adequate job of keeping their toes dry for the moment, but it won’t be too long before the tide of change sweeps over the vast majority of the market.
https://www.fsb.org/2018/07/interest-rate-benchmark-reform-overnight-risk-free-rates-and-term-rates/
https://www.fca.org.uk/news/speeches/interest-rate-benchmark-reform-transition-world-without-libor
https://www.cftc.gov/PressRoom/Events/opaeventmrac071218