The GCF Repo Futures contracts have launched on the NYSE Liffe. Volume on the first day of trading was a modest 2,500 contracts — not too bad for the dog days of summer. The GCF Repo Indices are seen as a LIBOR alternative. And of course the LIBOR pricing scandal has fed into the marketing of the GCF Repo Indices and Futures, but misses the point of why LIBOR is broken.
When no one really cared too much about the credit risk in LIBOR — remember these are unsecured deposits — it was as good a short-term benchmark as one could find. Yes, it wasn’t a traded rate and the BBA panel construct was far from ideal, but it got the job done. The financial crisis taught traders and credit officers the painful lesson that not all banks are created equally, even over the short term. The LIBOR panel depended on the contributors being fairly homogeneous credit-wise. Come the crisis and the pricing in of counterparty risk by some (but apparently not all) of the panel members, LIBOR revealed itself as not the pure reflection of interest rates that it was assumed to be, but rather as a confused jumble. The LIBOR – OIS spread told the tale.
Enter the GCF Repo Indices. As an index derived from actual trades in a highly liquid market using underlying “safe assets” it would seem to be a better short term interest rate mousetrap. One missing piece was a viable futures market. That took the first steps to being sorted yesterday with the launch of GCF Repo Futures. The other piece is the development of derivatives that use GCF Repo as a benchmark. We’ve read where Nomura and Credit Suisse are quoting interest rate swaps using GCF Repo on the floating rate side. Both the futures and swaps will have to achieve broad market acceptance to displace LIBOR. It will take time. Finally, if the Treasury decides to use GCF Repo as the benchmark for the upcoming UST Floating Rate Notes it would really seal the deal. Benchmarking UST Floaters off of GCF Repo is still a long shot, but we have to think those odds are better with other benchmarks being tarnished.
In the meantime, read the FOW article, “Analysis: Solid start for GCF Index futures but an uphill battle lies ahead” published today for a look at the first day of trading and some analysis. In particular take note of the mention of the reduced liquidity in the Fed Funds market. For a number of technical reasons, the Fed Funds market is a shadow of its former self and, like LIBOR, may not be the stuff of market driven benchmarks anymore. The article said, “…According to a note from Morgan Stanley, the GCF Repo index is more liquid than Fed Funds, trading in which has declined from over $250bn to $50bn per day since the financial crisis. The decline in trading has resulted in a decoupling of the correlations between the benchmark and money market rates…” If Fed Funds and LIBOR are out of the running, it could be GCF Repo’s time.