quo vadis ibor - tma austria...quo vadis ibor wien 25. april 2019 . page 1. what´s the problem with...

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Quo vadis IBOR

Wien

25. April 2019

What´s the problem with current

Interbank-Offered-Rates

2. Trend towards Overnight Risk-Free

Rates

3. Term Risk-Free Rates – The last step

to replace IBORs?

4. What should we do now?

2

Agenda

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Widespread – Heavily Used

What is the problem?

Why are there talks about

replacement?

3

1. Interbank Offered Rates (IBORs)

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THE LEGACY OF IBORS InterBank Offered Rates, IBORs, are used to benchmark over $370 trillion of financial

products in five currencies.

Source: ISDA/Reuters. Figures reflect face value of contracts benchmarked as of 2014.

*Euribor is the Euro Interbank Offered Rate and is distinct from euro-denominated Libor. Tibor, the Tokyo

Interbank Offered Rate, also differs from from yen-denominated Libor.

4

IBORs are used to price & value:

OTC derivatives and ETDs, which you may trade with banks to hedge interest rate or cross-currency risk

arising from business exposures, borrowing under loans and note issuances.

Floating-rate notes and callable debt issuance, which reference IBORs and which may be rated by the rating

agencies.

Debt instruments, i.e. loans, bonds, etc.

LOAN MARKET IN EURO AREA

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PANEL BANK MEMBERSHIP

0

5

10

15

20

25

30

35

40

45

50

EURIBOR Panel banks1

Settlement case, Dec 2013

Barclays € 0,0

DB € 465,9

SocGen € 227,7

RBS € 131,0

Total, EUR mln € 824,6

Fines, Dec 2016

Credit Agricole € 114,7

HSBC € 33,6

JPMorgan Chase € 337,2

Total, EUR mln € 485,5

European Commission fines and

settlement case details with the cartel in

Euro interest rate derivatives (EIRD)2:

6 1…Source: EMMI

2…Source: European Commission:

http://europa.eu/rapid/press-release_IP-16-4304_en.htm
















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IOSCO PRINCIPLES AND EUROPEAN BENCHMARK

REGULATION

7

IOSCO principles: The data used to construct a Benchmark should be - Robust - Transparent - Be anchored by observable transactions where possible

EU BMR: Since 1.1.2018 each regulated institution has to define an alternative rate (fallback) in case the benchmark rate used in contracts is not published anymore From 1.1.2020 only registered benchmarks (in line with EU BMR) are allowed to be used in new financial contracts => in March 2019 the EU parliament agreed on an extension of this BMR deadline for critical and third-country benchmarks till 31.12.2021

Page Source: ICE Benchmark Administration 8

Waterfall methodology transition in progress and should be finished soon. First impacts were observable recently.

LIBOR WATERFALL METHODOLOGY

Level 3: Expert Judgement

Market and transaction data-based expert judgement, using the bank‘s own internally approved procedure (based on a set of permitted inputs and agreed with IBA).

Level 2: Transaction-Derived

Transaction-derived data, including time-weighted historical elligible transactions adjusted for market movements, and linear interpolation.

Level 1: Transaction-Based

A VWAP of elligible transactions, with a higher weighting for transactions booked closer to 11:00 am London time.

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DEFINITION OF IBORS

9

To increase the volume of observable transactions also the definition of the benchmarks has been changed. old BBA LIBOR: “…. derived from the rates at which banks are willing to lend funds to one another in the London inter-bank market” new IBA LIBOR: "A wholesale funding rate anchored in LIBOR panel banks’ unsecured wholesale transactions to the greatest extent possible …" current EURIBOR: “ Euribor® is the rate at which Euro interbank term deposits are offered by one prime bank to another prime bank within the EMU zone. “ planned EURIBOR (hybrid): “ .. at which wholesale funds in euro could be borrowed by credit institutions in the EU and EFTA countries in the unsecured money market.”

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THE END OF LIBOR IN 2021?

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“ Our intention is that, at the end of this period (2021), it would no longer be necessary for the FCA to persuade, or compel, banks to submit to LIBOR. ” July 2017, Andrew Bailey, Chief Executive of FCA

Hybrid methodology shall ensure

compliance with the EU Benchmark

Regulation, BMR, effective 2020.

€STR, the Euro Short Term Rate, shall

replace EONIA.

Daily €STR publication from the 02nd

October 2019.

EONIA methodology will change to €STR +

spread from 2nd October 2019 and will

most likely discontinued on 3rd Jan 2022

ISDA will release fall-back language for

derivative contracts considering public

consultations.

Any publication beyond 2021 will be based

on voluntary submissions from banks and,

as a result, may not include all of current

LIBOR currency and tenor pairs.

Alternative risk-free rate are being

developed.

“The UK market regulator has recently re-

emphasised that LIBOR will not be

sustainable beyond 2021, and that market

participants need to have robust fallback

arrangements in place.”

EURIBOR is the long-term solution for

the EUR market, present focus is on a

fall-back rate (BMR compliance).

LIBOR shall be discontinued end of

2021, as most recently communicated.

CURRENT STATUS

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What happens internationally ?

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2. Trend towards Overnight Risk-Free

Rates

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To have a fallback in case of discontinuation of IBORs, working groups were

put in place in the different jurisdictions to find alternative Risk-Free Rates

During this evaluation the focus more and more went towards an Overnight

Risk-Free Rate because in that tenor volume of observable transactions is still

the highest

Unfortunately the majority of existing overnight rates still did not fullfill the

IOSCO principles, therefore also here overnight Risk-Free Rates are in the

process of being adapted or replaced

Decission between secured or unsecured overnight rates was a big

discussion point in all jurisdictions

13

RISK-FREE RATE

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CURRENCY

LIBOR

PREFERRED

ALTERNATIVE ADMINISTRATOR NATURE

DATA / TRANSACTIONS

SOURCE

O/N RATE

AVAILABLE

TERM RATE

AVAILABLE WORKING GROUP

€STR1 ECB Unsecured MMSR transaction data

To be

published by

Oct 2019

Under

consideration

Working Group on Euro

Risk-Free Rates

Reformed

SONIA2 Bank of England Unsecured

Unsecured overnight

sterling transactions

negotiated bilaterally and

brokered in London by

WMBA

Under

consideration

Working Group on

Sterling Risk-Free Rates

SOFR3 Federal Reserve

Bank of New York Secured

Tri-party repo, FICC GC

repo, FICC bilateral

treasury repo

Planned

2021

Alternative Reference

Rates Committee

(ARRC)

SARON4 SIX Exchange Secured CHF repo transactions in

the interbank market

Under

consideration

National Working Group

on Swiss Franc

Reference Rates

TONAR5 Bank of Japan Unsecured Data provided by money

market brokers

Under

consideration

Study Group on Risk-

Free Reference Rates

1… Euro Short-Term Rate, 2… Sterling Overnight Index Average, 3… Secured Overnight Financing Rate,

4… Swiss Average Rate Overnight, 5… Tokyo Overnight Average Rate

Source: Oliver Wyman, Changing the World’s most important number, Libor Transition, 2018

RFR ACROSS THE GLOBE – CURRENT STATUS

14

2017 2018 2019 2020 2021 2022+

SARON selected as the new O/N RFR

TOIS FIXING stopped to be published

SWISS Working Group publishes recommendation to close existing CHF LIBOR contracts till end of 2021 and replace them with compounded SARON or fixed rate

End

of

LIB

OR

?

LIBOR Transition to Waterfall Methodology

Apr18: FED begins SOFR publication in paralell to FED Funds Rate

Cleared SOFR Swaps starting to trade on existing PAI* and discount curve

CCPs might start to accept swaps with SOFR as PAI*

CCPs will not accept EFFR as PAI* anymore

Growing liquidity in SOFR Swaps and Futures

Term Rate based on SOFR?

EURIBOR Transition to Waterfall Methodology

ECB announces €STR and

working group recommends

this as the alternative Risk-

Free Rate for EURO

Oct 19: First €STR publication and change of EONIA Methodology

EURO RFR WG working on Term Rate Methodology

Term Rate based on €STR

ready to be used as

fallback to EURIBOR

CCPs might switch to €STR as only PAI* and discounting curves needs to be changed now at the latest

Cleared €STR Swaps starting to trade on EONIA PAI*

TRANSITION TIMELINE

*PAI ... Price Alignment Interest = overnight cost of funding

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Timing for feeding the fixing rate might need to be changed in the internal IT systems (for example: T+0 to T+1 for EONIA )

Historic overnight rates are embedded in many different legal contracts (especially derivative collateral agreements) as well as being traded in their own right

This creates significant complexity when transitioning to a new Risk-Free Rate

• Bilateral CSA contracts needs to be amended

• CCPs will change the O/N rate for the collateral and will change to new discount curve

• Discount curves needs to be changed, maybe dual discounting for limited time, maybe clean discounting but different discount curve per counterparty, etc.

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TRANSITION PERIOD OVERNIGHT RISK-FREE RATE

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The last step to replace IBORs?

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3. Term Risk-Free Rates

Current communicated path is that EURIBOR hybrid will be the long term

solution for a term rate in the Eurozone and that only a fallback is needed. This

differs significantly from the current plan for LIBOR. Questionable whether the

current panel banks will be happy to continue to contribute in the long term.

2. Additional complexity is that ISDA already has certain fallback proposals for

derivative contracts that does NOT include a term rate alternative that is forward

looking rate.

3. There is currently no consistency between jurisdictions as to the methodology

that should be used for constructing a term rate based on the overnight RFR.

4. Main difference between these methodologies and the IBORs is the credit or

liquidity spread element in IBORs.

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€STR-BASED TERM STRUCTURE METHODOLOGIES

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There are two main methodological options for an €STR-based term rate:

1. Backward-looking, based on the actual O/N rate

• In arrears, e.g. observation and rate accrual period are equivalent

• In advance, e.g. the rate is based on historical rates and thus it is known before the accrual

period starts

2. Forward-looking, based on the expected O/N rate, transactions, quotes, or a combination

of both, in the derivatives and/or futures markets

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€STR-BASED TERM STRUCTURE METHODOLOGIES

t0 rate determination period = rate application period

t1

settlement date

Rate only known at the end of the period.

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MARKET ADOPTION PHASE (since March 2019)

PREPARATION PHASE (since September 2017)

Work stream 1

Identify and recommend

(an) alternative RFR(s)

Work stream 2

Identify and recommend

a term structure for

RFR(s)

Work stream 3

Contractual robustness

for legacy and new

contracts

Work stream 4

Transition from EONIA to

the alternative RFR(s)

Work stream 5

Adoption by cash

products & derivatives

Work stream 6

Financial accounting &

risk management issues

Work stream 7

Communication towards

& education of all market

participants

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STRUCTURE OF THE WORKING GROUP ON EURO

RISK-FREE RATES (RFRS)

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KEY TARGETS OF THE EUR WORKING GROUP

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• Ensure a successful transition of the overnight rate from EONIA to

€STR

• Support implementation of a new term benchmark referencing €STR

• Propose a spread methodology to calculate the difference between a

term RFR and EURIBOR

• Analyse the interaction between Forward- and Backward-looking

methodologies to ensure minimal impact for end clients

• Support the contractual changes to incorporate suitable benchmark

fall-back language.

Contract currently

referencing EURIBOR

Contract once fall-back

triggered, referencing RFR

Fixed issuer-

specific loan spread

Floating

EURIBOR

reference rate

Fixed issuer-specific

loan spread

Floating term RFR

Fixed bank liquidity /

credit spread at time

of fall-back trigger

CONTRACTUAL CHANGES TO BENCHMARK LANGUAGE

4. What should we do now?

What challenges are we facing?

How do we react to them?

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Impact on business segments

Retail & Corporate Business

Treasury & Capital Markets

Risk Management & Financial Controlling

Methodology

Profitability

IT

Legal questions

Communication & reputation

The elimination of LIBOR has various topical as well as cross-segmental impacts ! Severe impact Moderate impact Little to no impact

Product pricing

Income at risk - costly fallback solutions

Maintenance of systems (e.g. EUC)

Adjustment of contractual clauses

Communication to clients & committees

Management open interest rate risk & basis risk, FTP

Hedging costs

Maintenance of systems (e.g. EUC)

Adjustment of contractual clauses

Communication Capital Markets, Stakeholder & committees

Accounting & Risk- Models

(Income) Impact on Hedge Accounting

Switch of booking systems O/N

n.a.

Communication internal stakeholders & committees

SEVERE IMPACT ON ALL BUSINESS SEGMENTS – MOST IMPACT EXPECTED ON TREASURY AND CAPITAL MARKETS

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Dimension Factors for success

• Nomination of Senior Executive as project sponsor and set-up of a central project management

• Timely creation of transparency on impact on profitability, methodology and business segments

• Timely planning due to high level of complexity

• Timely development of stakeholder-communication

• Agile approach supports content flexibility with predefined deadline

Profitability

Steering & Methodology

IT

Legal questions

Communication & reputation

!

MASTERING THE CHALLENGES SUCCESSFULLY BY A TIMELY AND CENTRALLY STEERED PROJECT: SIT AND WAIT IS NO OPTION

René Brunner Head of Money Market Trading

[email protected]

Thomas Einramhof Head of Group Treasury Markets

[email protected]

Robust and representative overnight Risk-Free Rate is essential

Transition to New RFR should be as smooth as possible

How to create a robust term-rate based on O/N RFR which can replace

IBORs?

Consistency through asset classes and jurisdictions desired/needed

SUMMARY

It´s time to act now and prepare for the change!

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ANNEX

27

More information about the working group on euro risk-free rates and the progress on that topic you can find here: https://www.ecb.europa.eu/paym/initiatives/interest_rate_benchmarks/WG_euro_risk-free_rates/html/index.en.html

WORKING GROUP ON EURO RISK-FREE RATES

https://www.ecb.europa.eu/paym/initiatives/interest_rate_benchmarks/WG_euro_risk-free_rates/html/index.en.html













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