By Jim Mahn, Global Head of Product, TraditionData.
With the USD London Interbank Offered Rate (LIBOR) scheduled to be phased out by June 30th this year, its remnants have the capacity to cause disruptions as derivative contracts based on LIBOR will most likely still exist. Allied with the present economic conditions and the market volatility this creates, a dependence on quality data to help navigate this market landscape will only increase.
Until USD LIBOR’s official expiration and a total switch to the Secured Overnight Financing Rate (SOFR), we will see institutions and trading teams around the world continue to use, but wind down, debt product transactions based on rates with varying maturities.
Nevertheless, as regulatory bodies like the FCA and SEC continue to support a limited set of synthetic US Dollar LIBOR for legacy contracts only until September 2024 (1-month, 3-month & 6-month), managers and trading teams in the OTC market will be preparing for the eventual deadline and focusing on how best to manage and navigate this new reality.
Scale of transition significant
It is over a decade since serious concerns were highlighted on the efficacy of LIBOR as a rate system, and a three-year period for its successor to gradually transition into place. In the UK, one and six-month synthetic sterling LIBOR ended in March 2023, whereas in the US, one-month, three-month, six-month, and twelve-month maturities will continue until the middle of the year (or longer). This staggered approach has attempted to smooth the transition, but challenges remain, particularly in the swaps market.
First, we need to recognise the scale of the transition, which underscores the time constraints facing the industry. Clearinghouses have around ~$60 trillion of cleared USD swaps to be converted onto SOFR by mid-year , which will require a thought-out transition strategy by market participants, who will need to manually rebook all of their cleared trades from a LIBOR trade to a SOFR trade. Secondly, the current ban on interdealer trading of term SOFR derivatives has been suggested by some market observers to pose a potential risk to swap dealers, due to prices deviating from instruments linked to the compounded (in-arrears) version of the rate. Term SOFR derivatives are usually priced one – five points more than the regular SOFR swap, posing a further challenge to banks.
Data, data, data
In the midst of the current market transition, access to high-quality, accurate and timely data services is what institutions will need to gain the upper hand. Transparency and leading indicators of information are crucial in any market, and so access to data that gauges what the following day’s SOFR rate will be, can be the key insight needed. This can be achieved by sourcing a market data provider that produces rates published in hourly snaps to provide a view into where the SOFR fixes on a particular day.
As the data landscape continues to evolve, with consumption and aggregation of more and more data and analytical capabilities developing in tandem with technology improvements, accurate and consistent valuable market data for use within this complex sector of our global financial markets is invaluable. And what’s more, the individuals and teams to whom this data is presented need to trust its reliability.
As not every curve of surface point in OTC markets is processed or traded every day, organisations should look to market data providers that can offer an intimate knowledge of local markets and are able to enhance, through analytical models, the breadth, scope and depth of yield curves and volatility surfaces to provide the maximum value around these otherwise opaque marketplaces. Then it needs to be packaged and presented in a digestible form by a Market Data team.
As the industry nears the final stretch of the transition, having a secure, solid, and reliable provider of pre-trade data intelligence is crucial for banks and institutions to become more accustomed to operating under a different system. Financial institutions should therefore look to high quality OTC data providers with many decades of experience, expertise, and data to provide such support.
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