The global market is making great strides in its transition away from Interbank Offered Rates (IBORs) to Risk Free Rates (RFRs), according to recently published Q3 2021 research from OSTTRA and based on data processed by MarkitSERV. In a Q&A with DerivSource, Kirston Winters, Head of Legal, Risk, Compliance and Government and Regulatory Affairs at OSTTRA, shares the milestones met in the recent quarter and how this paves the way towards future compliance across various currencies and jurisdictions in the swaps market.
Q. OSTTRA reports various milestones were met in the last quarter (Q3) of 2021. Can you briefly explain the biggest milestones and their significance to the swaps market and wider financial industry?
The timeline to IBOR cessation is very well publicised. SONIA has led the way, but the continued focus from regulators, combined with initiatives such as SOFR first, is leading to greater traction in other currencies in recent months. There has also been several CCP conversions taking place, to convert legacy portfolios. For example, last weekend was the EONIA To EuroSTR switch across multiple CCPs. From our perspective, we have supported all the new rates for a long time. We added SOFR to MarkitWire on May 12th back in 2018. However, based on customer demand we made SGD-SORA-COMPOUND, EUR-EuroSTR-COMPOUND, and USD-SOFR-COMPOUND the defaults for the applicable OIS templates from September 11th, 2021.
Specifically, can you elaborate if you think the SOFR first initiatives will continue to ramp up the transition within the US?
There has been a clear uptick in SOFR liquidity, which is undoubtedly driven by the initial phase of the SOFR first initiative for interbank swaps. As this initiative is phased, we would expect its impact to continue to grow over the coming months.
In parallel to this there remains much debate about term rates and credit sensitive rates, for example BSBY. We saw the first few USD BSBY trades processed in September, after adding support for it on July 24th, 2021, so this is definitely one to watch.
Q. Is the recent sharp progress in SARON and SORA and TONA surprising? If so, why or why not?
SARON’s progress is in many ways unsurprising as the CHF-LIBOR cessation has a hard deadline at the end of 2021.
In Singapore, for example, although the migration to SORA is not mandated, MAS has been encouraging firms to adopt SORA. There has also been active participation through the association of banks of Singapore’s Singapore Steering Committee for SOR & SIBOR Transition to SORA (SC-STS). This appears to have led to the acceleration of adoption over the last quarter.
TONA’s recent sharp rise was driven by the timeline of TONA First Initiative set by the Bank of Japan’s Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks.
Q. With Dec 31st 2021 rapidly approaching, there is little time left for financial institutions and the UK market to complete its transition away from LIBOR to SONIA. Can you share what you believe needs to happen in the next few months to ensure a smooth transition? What challenges do UK firms still need to overcome?
2021 has been a year of unprecedented change across the OTC Interest Rates derivatives markets. In addition to the broader adoption of the new RFRs across products, there have also been many bulk cleared conversions for IBOR reform. Firms have also been grappling with the adoption of the 2021 ISDA Interest Rate Derivatives Definitions which is a new set of Contractual Definitions that are replacing the legacy 2006 version of the definitions. Given this, there has been very little time for firms to take into consideration all aspects of the conversion to new RFRs.
There is plenty of liquidity in SONIA, indeed the FCA’s recent policy paper has applied the DTO to SONIA and removed it from LIBOR from December 20, 2021. The challenge is more of the industry coalescing around transition strategy and ensuring they have a plan to adopt SONIA broadly, including in non-linear derivatives. In the bilateral (non-cleared) space, you may still see IBOR swaps converted even after cessation as some firms are unable to convert everything by cessation and will rely on fallbacks in the interim.
Q. What do you believe will be the most significant milestones the industry will see next?
From our perspective, there will be some significant issues coming up that the industry must face. Firstly, the cliff edge decline in EONIA volumes now that the CCPs have converted all EONIA positions to €STR and will no longer clear EONIA. Following on from this, the adoption of SOFR in the Non-Linear markets now that there is a plan to publish the ICE Swap Rate (ISR). There has been rising adoption in SOFR since the CFTC announced the SOFR initiative, however, there has been lack of adoption in products like swaptions as firms could not cash settle without the ISR. The cessation of all sterling, euro, Swiss franc and Japanese yen settings, and the 1-week and 2-month US dollar IBOR settings on 31 December 2021, and the publication of synthetic LIBOR. Lastly, there is also the potential emergence of the broader usage of term rates e.g., Term SOFR and credit sensitive rates e.g. BSBY.