2018年-普华永道全球_US_perspectives_on_adjustments_to_overnight_risk_8页_658kb

LIBOR Transition Series: ISDA Consultation on Overnight Risk-Free Rate Adjustments

Core Content

The ISDA consultation, launched on July 12, 2018, focuses on the transition from Interbank Offered Rates (IBORs) to alternative Risk-Free Rates (RFRs), particularly in the context of moving from term rates to overnight rates. The consultation explores four potential methods for adjusting the applicable RFRs to approximate the behavior of IBORs. These methods aim to address the structural differences between RFRs and IBORs, ensuring that derivative contracts can continue to function effectively in a post-LIBOR environment.

Main Approaches

The four approaches for adjusting RFRs are as follows:

1. Spot Overnight Rate (SORf)

   • Description: The fallback rate is the RFR that sets at the beginning of the interest period.
   • Advantages: Easy to understand, simple to implement, and relies on readily available information. It reflects one-day borrowing rates just before the interest period.
   • Disadvantages: Ignores variation in interest rates over the period, may be more volatile, and does not mirror the structure of overnight index swaps.

2. Convexity-adjusted Overnight Rate (CORf)

   • Description: Similar to SORf, but with a first-order adjustment to account for daily compounding of the overnight RFR.
   • Advantages: Better reflects the term structure of risk-free interest rates, and is more comparable to term IBOR exposure.
   • Disadvantages: May not match the shape of the term structure, especially in volatile markets. It introduces complexity and may still be more volatile than compounding methods.

3. Compounded Setting in Arrears (ARRf)

   • Description: Uses the daily RFR observed over the relevant LIBOR tenor, compounded daily during that period.
   • Advantages: Reflects actual interest rate movements, is less volatile than spot methods, and mirrors the structure of overnight index swaps.
   • Disadvantages: The required data is not available at the start of the period, and actual movements may not reflect expectations.

4. Compounded Setting in Advance (ADRf)

   • Description: Similar to ARRf, but the observation period ends immediately before the start of the relevant IBOR tenor.
   • Advantages: The rate is known at the beginning of the period, and it reflects actual interest rate movements over a comparable tenor. It is less volatile and more reflective of current interest rate data.
   • Disadvantages: It is inherently backward-looking, which may lead to differences from current market conditions and affect hedging in volatile environments.

Key Observations

Observation 1a: Volatility of Spot Methods (SONIA)

• The SORf and CORf methods are more volatile than the compounded methods (ARRf and ADRf).
• Over a one-month interest period, the maximum historical rates for SORf and CORf are 78-82 bps higher than for ARRf and ADRf.
• The disparity is even more pronounced for six-month periods, with SORf and CORf showing up to 115 bps higher maximum rates.
• The standard deviation of the spot methods is also higher than that of the compounded methods.

Observation 1b: Volatility of Spot Methods (SOFR)

• SOFR data, despite being in a relatively stable environment, still shows that SORf and CORf are more volatile than ARRf and ADRf.
• The spread between SOFR-adjusted rates and one-month USD LIBOR fluctuates significantly, with SORf and CORf showing a range of -3 to 42 bps.

Observation 2a: Lag in ADRf (SONIA)

• ADRf lags behind current interest rates, especially in high volatility and longer tenors.
• During the 2007-2009 financial crisis, the lag effect between ADRf and ARRf was significant, with differences up to 200 bps for one-month and nearly 450 bps for six-month periods.

Observation 2b: Lag in ADRf (SOFR)

• The lag effect is also observed in SOFR data, though the environment has been relatively stable.
• The spread between ADRf and one-month USD LIBOR fluctuates more than that between ARRf and LIBOR, indicating the lag effect.
• In a more volatile environment, the differences would be more pronounced.

Closing Considerations

• None of the proposed methods can fully replicate the behavior of LIBOR, but they provide practical ways to approximate term rates using overnight RFRs.
• The ARRf method is considered the least volatile, least susceptible to manipulation, and most reflective of current interest rate data during the interest term.
• The consultation is open for feedback until October 12, 2018, and all market participants are encouraged to contribute.

Key Takeaways

• Four adjustment methods (SORf, CORf, ARRf, ADRf) are proposed to replace IBORs with RFRs.
• Volatility is a major concern with spot methods (SORf and CORf), which are more volatile than compounded methods.
• Lag is a concern with ADRf, as it reflects past data rather than current conditions.
• ARRf is highlighted as the most stable and representative method.
• The consultation aims to find the most suitable method for the transition to RFRs, with the goal of ensuring economic consistency and reducing manipulation risks.

Appendix

• ISDA provided graphs illustrating the historical behavior of the various RFR adjustment methods.
• These graphs show that the volatility and lag effects are more pronounced in longer tenors and during economic crises.
• The graphs also compare the performance of the methods against one-month USD LIBOR.

Additional Information

• Contact details for PwC professionals involved in the consultation are provided.
• PwC emphasizes the importance of trust and solving complex financial problems.
• The publication is for general guidance and does not constitute professional advice.