Repo Indices, Overnight Index Swaps and Other Alternatives to LIBOR

Finadium
August 2012

Finadium reports are distributed primarily by subscription. If you are a research subscriber, please log in to download a copy of this report. Otherwise, please contact us at info@finadium.com.

The LIBOR scandal has been the tipping point for a change in short term interest rate benchmarks. But false submissions are just the start: the weaknesses in LIBOR go far beyond the current scintillating scandal and extend to its vulnerability as a carrier of counterparty credit risk. Mixing credit and interest rate risk in an unpredictable way is asking for trouble, but weaning the LIBOR benchmark of off $800 trillion in derivatives, loans, and mortgages is a daunting task.

After LIBOR, what are the alternatives for a reliable, global financial benchmark? Fed Funds and its derivative Overnight Index Swaps (OIS) are two options, but recent Federal Reserve and FDIC changes have impacted Fed Funds liquidity.

The alternative with promise is repo, and specifically repo on “safe assets” like US Treasuries, Agencies, and Mortgage-Backed Securities. But the repo business has traditionally been opaque and not without its issues in the financial crisis. It is also part of the Shadow Banking investigations currently underway by the Financial Stability Board. New repo indices created by the DTCC go some ways to address transparency issues, but indices alone will not create a new benchmark; a robust futures and derivatives market must also be part of the solution.

In this report, Finadium evaluates the mechanics and difficulties of LIBOR, and assesses Fed Funds, OIS and repo indices as possible substitutes for LIBOR in financial markets.

This report should be read by traders, institutional investors, policy makers and market intermediaries to gain a robust understanding of how alternatives to LIBOR will affect their daily activities.

This report is 37 pages with 9 exhibits.

TABLE OF CONTENTS
■ Executive Summary

■ Life After LIBOR
– What’s Wrong With LIBOR Besides False Submissions?
– LIBOR and Credit Risk

■ The Trouble with Fed Funds
– Reg D and Interest on Excess Reserves
– The FDIC Expands Insurance Premiums
– The OIS Market

■ Understanding Repo Indices and Futures
– Trading Repo Futures

■ Building Tomorrow’s Financial Market Benchmarks
– Is There a Case for Repo Indices and Futures?

■ Appendix A: Specials, General Collateral and
Transparency in the Repo Markets

■ About the Author

■ About Finadium