By Andy Ross, CEO, CurveGlobal
17 Mar 2021
It’s only when you have an earthquake or other systemic shock that you really value having deep foundations. It’s a secret to the success of the iconic buildings of the City of London but it‘s also vital for the markets themselves, which they support.
The Bank of England, the PRA and FCA have played a leading role in recent years on global Reference Rate reform. Much like the underpinnings of the historic and current city, however, solid foundations matter. While LIBOR had been carefully administered by ICE benchmark administration in recent years, it was deemed by the prudential authorities as no longer fit for purpose. Why? Well, no-one actually trades unsecured loans (the trade that gives its price to LIBOR) any more, so it’s only the markets’ best estimate of what the rate might be.
LIBOR has been described as the world’s biggest number – and is used as the underlying rate in literally trillions of pounds of risk. Whether it be your pension, mortgage, or loan it is almost certain that you have products linked to this reference rate. In my view, therefore, the UK regulatory body decided correctly that building a market on estimates posed too big a risk. And last Friday it announced that it will cease at the end of this year.
The lessons from 2008
The lessons learnt from the 2008 financial crisis show the value of having solid underpinnings and what happens when you don’t.
The BoE1 led a working group of industry and market experts and decided to migrate the underlying interest rate of financial products in GBP from LIBOR to SONIA (Sterling OverNight Index Average)2. This process – coupled with rules changes, market development, and a “SONIA first” approach – has led to an explosion in uptake. Looking at the ISDA/Clarus RFR adoption data3 you can see the percentage of DV01 (a measure of risk, the impact of a 1 basis point move) in interest rate swaps executed with one of these “reformed rates”.
In GBP in January 2021 the percentage of DV01 traded as a reformed reference rate had climbed to 46% of the market. This compares to changes in the EUR market where uptake has been more sedate at just 1.2%. This is not to say that uptake and change is easy, it’s actually hard. However, the fact that the BoE worked with the market to make it more stable is a great example of solid foundations.
In any market, certainty matters
The US is also trying to change their market, with a brand new reformed rate (SOFR), with progress being made at a peak of 10% traded. The cessation (to use the technical term) of Sterling LIBOR was announced on Friday by the BoE and FCA. This has the effect of pouring concrete into the market’s foundations. A calculation now tells the user exactly how much their interest rate moves when you switch from LIBOR to SONIA. In any market, certainty matters. This is no exception and will trigger a significant acceleration in this migration.
This subject is more than of academic interest for me, as the CEO of LSEG’s CurveGlobal, a business that lists SONIA futures that clear at LCH. We compete with another two exchanges to offer an alternative vision of the market’s future. Without the UK’s engagement and migration from LIBOR to SONIA, platforms such as CurveGlobal would be unable to grow and compete.
This is important for the market as the FCA has a “competition” remit as well as market stability and enforcement. It must consider the impact that our activities have on competition and it must promote competition in the interest of consumers. The fact that competition is to be encouraged for the benefit of customers, including market structure, is key.
The UK remains the perfect place to develop a business
From my perspective, the UK is the perfect place to develop a new business. Look again at the foundations, not of the tower blocks or historic buildings, but the actual market. Leading the world in reference rate reform, at the vanguard of change in delivering pro-choice, open and highly competitive markets, London and the UK remains at the epicentre of global finance. As a result it is providing the perfect building block for innovative companies such as CurveGlobal, with its mission to modernise the exchange traded futures market.
___________________
About Andy Ross
Prior to heading up CurveGlobal at LSEG, Andy was previously a Managing Director at Morgan Stanley where he was the Global Head of Listed Electronic Execution & European Head of Derivatives Clearing. Andy is a known industry expert, and is heavily involved in a number of key industry initiatives in the listed, OTC and counterparty risk management space; including having previously served on CCP risk committees and industry association boards.
1 https://www.bankofengland.co.uk/markets/transition-to-sterling-risk-free-rates-from-libor