10 September 2018
There are currently two open consultations connected with Interbank Offered rate (IBOR) reform, the ISDA consultation on IBOR fallbacks and the Bank of England (BoE) consultation on Term SONIA rates.
The ISDA consultation is concerned with agreeing fallbacks which will apply to derivatives contracts referencing IBOR if it is discontinued.
There are two distinct parts to the consultation:
1. To determine how to adjust the relevant risk free rates (which are overnight rates) to be consistent with the IBOR rates (which are published for 1,3,6 and 12 month tenors)
2. To determine the spread adjustment which should apply to reflect that the IBOR rates incorporate a bank credit risk premium.
A variety of different options are presented in the consultation, which require a trade-off between avoiding a large exchange of value between counterparties (if the parameters are based on averages which are significantly different from current market levels) and avoiding the potential for market manipulation / market volatility (if the parameters are based on the actual levels applying on a particular date).
The BoE consultation is designed to support markets that need term rates rather than overnight rates. Term SONIA reference rates (TSRR) are designed to represent the market’s expectation of the average value of the risk-free rate, SONIA, over a designated tenor.
The BoE consultation paper investigates a variety of different data sources to determine the best approach to calculate TSRR, which seeks to address the trade-off between robust data (actual traded prices rather than estimates) and the need for an appropriate volume of data from relevant markets.
We would encourage all actuaries to assess the impact of these consultations and, if appropriate provide a response in advance of the official deadlines of 30th September (BoE) and 12th October (ISDA).
The members of the IFoA working party on LIBOR reform are: Simon Richards, Hetal Patel, Jon Neale, Robert Pace, Cyprian Njamma, Nicol Strachan, Emma McCallum, Peter Lin, Ross Fleming, Mahesh Bora and Udit Kapoor