LIBOR – Back to the future
Does the past impact the future, Doc?
Lots of excitement in GBP Basis of late after the International Swaps and Derivatives Association (ISDA) finally launched the consultation into the fallback parameters – responses due 23 October, so expect results a few weeks later.
From the document the following options are primarily under consideration.
- Median over five year lookback period from date of announcement / publication of information regarding cessation.
- Trimmed mean over ten year lookback period from date of announcement / publication of information regarding cessation.
The headline for this is clearly that Floating Rate Agreement (FRA) SONIA basis post cessation should be tighter than it is now, but whilst this provides clarity – there’s also further confusion around how you interpret the text “from date of announcement / publication of information regarding cessation”.
From the argument given by respondents who favoured 5yrs because 10yrs would capture the financial crisis, it seems people are thinking that this spread is going to be calculated in advance of cessation rather than post end of 2021 as one would expect. Surely the point of cessation is after 2021 when Banks are no longer compelled to contribute, cessation is announced, therefore >2021 – 10yrs = >2011.
Were these respondents interpreting this to mean the fallback spread would be calculated in advance of cessation occurring – at the point the fallback language is agreed? The trigger for LIBOR ending is something we've discussed before, and with recent pre-cessation consultation preliminary results not helping, it's a key topic to debate further.
What if for some (admittedly unlikely) reason cessation didn’t occur for some years after the expected 2022 date – we’d use an average calculated over a period of 5yrs from now – that doesn’t seem like a very robust approach to take for the documentation, and with Bloomberg already announced as the calculation agent, we can be confident that they’ll be publishing an updated calculation of the spread daily using whatever the agreed methodology is as we approach a likely cessation date.
Currently, we still think this means when LIBOR actually ceases – not just when 'information around it ceasing at a future date' is published, ie this fixed basis spread will be calculated when LIBOR production ceases.
As we’d anticipated, we’ve seen FRA SONIA basis moving tighter.
No doubt there will be a sequel.
*A FRA is a contract for difference against, typically, a LIBOR fixing
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4th October 2019
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