Moving to a new Alternative Reference Rate (ARR) requires market liquidity, new legal contract terms and general acceptance of the new state of affairs in the relevant market from buy- and sell- side firms. Therefore, it is likely that all current Interbank Offered Rates (IBOR) will not transition at the same time for all products and markets. Author: John Alton
One of the practical challenges of the transition is liquidity in ARR instruments and the timing of the transition, in particular, for multi-currency products, such as cross-currency swaps. Similarly, the cash and derivatives markets are interconnected; one cannot transition without the other.
When it comes to liquidity, market participants are obviously in the driver’s seat; the more market participants shift away from using IBORs to using new ARRs, the quicker the underlying liquidity in ARR instruments will build up. The graphic below shows the current readiness of various markets / products to transact SARON-based products. However, just because a market now exists does not necessarily mean a deep pool of liquidity has built up.
The most recent development we have seen in the SARON market was EUREX’s launch of 3-month SARON Futures on 29 October 2018, the first exchange-traded SARON Futures globally. While we have yet to see the SARON Futures volumes develop, it is another step in supporting the market with an orderly transition to the new benchmark.
Currently, one of the major concerns of market participants with regard to the development of further products is the lack of a final agreed methodology for the development of a term rate based on SARON. In its meeting on 31 October 2018, the National Working Group (NWG) on CHF Reference Interest Rates recommended to use compounded SARON wherever possible. The main reason is that it is unlikely that a robust derivatives-based term fixing is feasible. So far, the NWG has not made a recommendation with regard to whether this should be a backward or forward looking approach, or an option in between, and it remains to be seen which methodology will be considered by the NWG as the most appropriate to be used in connection to SARON.
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 Presentation of Martin Bardenhewer, co-chair of the National Working Group on CHF Reference Interest Rates, at the event “LIBOR to SARON: Are you ready?” hosted by SIX on 1 November 2018.