UCL Financial Mathematics Practitioners Seminar
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1 UCL Financial Mathematics Practitioners Seminar Game of Benchmarks: LIBOR and IRON thrones Marc Henrard Advisory Partner - OpenGamma Visiting Professor - University College London
2 UCL Practitioners Seminar Financial Mathematics Game of Benchmarks: LIBOR and IRON thrones Marc Henrard Advisory Partner - OpenGamma Visiting Professor - University College London
3 November Questions! In mathematics, the art of posing a question is more important than the art of solving one. Georg Cantor, 1867
4 November Game of Benchmarks 1 Benchmarks LIBOR 2 Game 3 Mathematical finance 4 References
5 November Margins 1 Benchmarks LIBOR 2 Game 3 Mathematical finance 4 References
6 November Why benchmarks To save time! Reference interest rate set by the market and used to establish the rate on loans, bonds, or derivatives. Interest rate benchmarks: based on term rates or overnight rates.
7 November LIBOR London InterBank Offered Rate. At what rate could you borrow funds, were you to do so by asking for and then accepting interbank offers in a reasonable market size just prior to 11 am London time? Created on 1 January Published for GBP, USD, CHF and JPY; EURIBOR for EUR. Term rate: typically 3 and 6 months
8 November LIBOR BIS statistics: IR derivatives notional outstanding: USD 415,000,000,000,000 Cleared at LCH SwapClear in 2017: USD 760 trillions. S&P 500 market capitalisation: USD 23 trillions.
9 LIBOR - panels November
10 November LIBOR decrease of importance Unsecured lending has decreased a lot since the crisis. Volume (in USD billions) Interbank lending LIBOR creation Start crisis 0 Jan-75 Jan-80 Jan-85 Jan-90 Jan-95 Jan-00 Jan-05 Jan-10 Jan-15 Source: US Federal Reserve All Commercial Banks in the United States Interbank loans
11 November LIBOR decrease of importance Regulators have put the future of LIBOR existence in doubt: speech by Andrew Bailey (FCA) in July 2017 titled The future of LIBOR. Panel bank support to sustain LIBOR until end Alternatives: USD, CHF, GBP
12 November IR Derivatives: main types T 0 T 0 fixing IRS Exchange on a regular schedule a fixed rate against the LIBOR rate on its natural period, typically 3 months or 6 months. payment fixing T 1 payment fixing OIS Exchange on a regular schedule a fixed rate against the ON rate compounded over a term, typically 6 months or 1 year. payment t 1 t 2 t 3 fixing fixing T 1 fixing fixing payment T 2 t 5 t 6 t 7 fixing fixing T 2 fixing
13 November IR Derivatives: spreads multi-curve Boenkost and Schmidt (2004)* Tuckman and Porfirio (2003)* Fruchard et al. (1995) Johannes and Sundaresan (2007) Henrard (2007) West (2011)* Macey (2011)* Fujii et al. (2011) Bianchetti and Carlicchi (2011) Traven (2010)* Moreni and Pallavicini (2010)* Mercurio (2010a) Fujii et al. (2010b)* Bianchetti (2010) Piterbarg (2010) Henrard (2010) Chibane et al. (2009)* Ametrano and Bianchetti (2009) Kajima et al. (2009) Mercurio (2009)* Morini (2009)* Kenyon and Stamm (2012) Henrard (2012b)* Henrard (2013b)* Pallavicini and Brigo (2013)* Mercurio and Xie (2012) Piterbarg (2012) Spread 6M-3M Spread 6M-ON Spread 3M-ON
14 November Margins 1 Benchmarks LIBOR 2 Game 3 Mathematical finance 4 References
15 November New benchmarks LIBOR rates are based on unsecured lending. The importance of unsecured lending has decreased significantly. Some new benchmarks are based on secured lending, treasury repo in particular. LIBOR rates are based on term lending, with the most popular being 3-month and 6-month. More inter-bank lending is now done on an overnight basis. The new benchmarks pushed by regulator are often overnight based (SONIA, SOFR, SARON).
16 November New benchmarks: users What are the requirements from the end-users? ALM financials: borrowing (savings) v lending (mortgages). Pension funds: long term investments v liabilities (inflation?) Corporate: borrowing Term to overnight: time consuming! Original reason for benchmark is to save time. Proposals for new benchmarks have been done in several currencies, but there are still major questions. Already answers, still looking at posing right the questions!
17 November Fallback Even if LIBOR is not published anymore, transactions referencing it will still exists. Those transactions can be very long term (up to 50 years). What will happen to those transaction? Fallback clause exists in contract but are not designed for long term discontinuation of a benchmark. Fall-back proposal from ISDA is to replace LIBOR by a term OIS rate plus a deterministic term spread to be computed on discontinuation. The details of this deterministic spread need to be worked out. Even ignoring manipulation potential, simply computing the (forward) spreads already requires modelling.
18 November Game Spot the mistakes LIBOR EURIBOR SONIA EONIA POLONIA SONET RIR SOFR IDIOT TONAR SONAR SMART PAIRS PRISMA TRIPLET PIBOR TARGET SARON ARRC MARC BBSW RFR TIBOR FSB BCBS SAURON MUTAN CDOR MIFOR WIBOR IRON JIBAR HICP NZIONA HONIX POLONIUM CORRA EFFR AONIA BBA ICE FIRE RONIA TOIS SIOR WMBA ECB IOSCO EMIR
19 November Game Spot the mistakes LIBOR EURIBOR SONIA EONIA POLONIA SONET RIR SOFR IDIOT TONAR SONAR SMART PAIRS PRISMA TRIPLET PIBOR TARGET SARON ARRC MARC BBSW RFR TIBOR FSB BCBS SAURON MUTAN CDOR MIFOR WIBOR IRON JIBAR HICP NZIONA HONIX POLONIUM CORRA EFFR AONIA BBA ICE FIRE RONIA TOIS SIOR WMBA ECB IOSCO EMIR
20 November Margins 1 Benchmarks LIBOR 2 Game 3 Mathematical finance 4 References
21 November Pricing with multi-curve and collateral Multi-curve framework Description of existing curves. Interpolation mechanism are far from trivial (see spread for fallback). Design a good mathematical model with realistic dynamic: curve shape, spreads, curves order, etc. Impact of the change fallback clause on the existing trades? How to extract the fondamental components? Collateral framework VM mandated by EMIR regulation since March Value of the trade is paid in collateral. Interest is paid on the collateral at a benchmark rate. Theoretical impact of those payment are relatively well understood. How to change benchmark in practice? What are the best procedure to decrease the impact on the market?
22 November Replacement of LIBOR USD 415 trillions question! How to design a good benchmark; pricing should be clear in theory and easy in practice. What is a good fall-back procedure? From financial mathematics to lawmaking, instead of the inverse. Long-term IRS based on short term OIS or long-term OIS. Same valuation formula at the start, very different pay-off process.
23 November Conclusion Crisis induced changes in the market and require a review of the existing benchmarks. Regulatory induced changes in the market infrastructure have increase the importance of IR benchmarks. Mathematical finance models have to be adapted. There is still a lot of opportunities for research and development.
24 November Margins 1 Benchmarks LIBOR 2 Game 3 Mathematical finance 4 References
25 November Regulation FCA The future of LIBOR: news/speeches/the-future-of-libor EMIR European Market Infrastructure Regulation Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories. FSB Reforming Major Interest RateBenchmarks
26 November Magazine and blogs Multi-curve blog Game of benchmarks Mathematicians Quantitative finance still needs mathematicians Fallback The fraught search for a Libor fallback Libor transition Pimco calls for urgency on Libor transition Repo Libor s sunset sees US repo market cast a longer shadow
27 November Website Libor Libor-Wikipedia
28 November Thank you! Contact OpenGamma Web: Europe OpenGamma 185 Park Street London SE1 9BL United Kingdom North America OpenGamma 125 Park Avenue New York, NY United States
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