Risk-free rates (RFRs) will see the lion’s share of liquidity in the post-LIBOR world, but there are uses for alternative rates, including those with a credit-sensitive component, according to panelists at the ISDA (International Swaps and Derivatives Association) Annual General Meeting.
A variety of credit-sensitive rates have emerged as alternatives to US dollar LIBOR, including AMERIBOR and Bloomberg’s BSBY, as well as the forthcoming IHS Markit US dollar Credit Rate and the ICE Bank Yield Index. Speaking on a panel on liquidity in alternative reference rates sponsored by Murex, Sonali Theisen, managing director, head of FICC e-trading and market structure at Bank of America, said it is important to provide alternatives for those parts of the market that might struggle to adopt RFRs, such as loans.
“We think it is prudent to at least give the market choice and having a credit-sensitive option ready and available alongside SOFR [secured overnight financing rate] is the smoothest thing for markets as we undertake this massive paradigm shift,” she said, adding that this will likely help accelerate the transition away from LIBOR.
Speaking on the same panel, Jack Hattem, managing director, global fixed income, at BlackRock, agreed there will be some use cases for credit-sensitive rates and other alternatives like forward-looking RFR term rates, but stressed that liquidity will likely centre on SOFR in the US. “As the majority of liquidity, we believe, will still be in SOFR, education becomes very important. So, you have to understand the construction of these alternative indices that involve a credit component – how are they made, what is the appropriate fit? And then what’s the liquidity in those products and is there liquidity in derivatives for effective hedging purposes? Once you evaluate all of those, then you can decide what’s the most appropriate for your portfolio,” he said.
While there are no concrete plans to clear derivatives linked to credit-sensitive rates, Phil Whitehurst, head of service development, rates, at LCH, said this could occur in future if there is sufficient demand, and said the clearing house is sounding out its user base. “This is really going to be a dollar swap market that is very much SOFR-based in the future for pricing, discounting and valuations, so this is something that could be additional,” he said.
In an audience poll question on post-LIBOR interest rates, 46% of the audience thought interest rate portfolios will primarily comprise RFRs with overnight index swap conventions but with a mix of RFRs with other conventions and other alternatives. “It’s clear there is this expectation that RFRs will largely be used for, I think, most uses and then there may be cases where some other form is beneficial. I think we could certainly see that particularly with corporates,” said Chirag Dave, executive director, sterling rates trading, at Goldman Sachs.