TrueFX, an over-the-counter venue, aims to transform foreign exchange trading by allowing asset managers to connect to a credit network through one connection and cutting costs by between 60% and 80%.

Integral, the technology company, and Jefferies announced the  launch of TrueFX in November last year.

Harpal Sandhu, founder and chief executive of Integral, told Markets Media: “TrueFX is not just a trading venue it provides a credit network in a single ecosystem.”

Jefferies provides central clearing for the platform.

Brandon Mulvihill, global head of FX prime brokerage at Jefferies said in a statement: “The flow of credit is the lifeblood of the FX market, but market inefficiencies have stalled accessible and affordable credit for many market participants.”

The TrueFX Clearing Member network was launched this week with Axicorp, FXCM and Velocity Trade supporting customer access. Sandhu said: “We will double or treble the clearing members as there a lot of firms in the pipeline.”

Clients can clear through Jefferies FX prime brokerage or can open an account with a clearing member to directly access liquidity on the venue without an intermediary. Firms can provide customized pricing bi-laterally to all customers regardless of direct credit relationships.

A survey by consultancy Greenwich Associates said the “electronification” of FX is not limited to trade execution as there is a focus on increasing operational efficiency, especially in credit intermediation.

“Managing credit limits for individual clients within FX platforms and across banking businesses is a complex and arduous task,” said the report. “Vendors have started the process of automating the credit allocation process—an achievement that could unlock huge efficiencies in balance sheet utilization.”

*New* FX Execution: Competing in a World of Algos https://t.co/h4gY9r9Jdz via @GreenwichAssoc by #SatnamSohal, #FrankFeenstra pic.twitter.com/Y7vPVJzpbu

— Coalition Greenwich (a division of CRISIL) (@CoalitionGrnwch) October 22, 2019

The consultancy said new technology has the potential to revolutionize the FX business far beyond simple trade execution.

“In the coming years, innovations such as distributed ledger technology are also expected to make back-office operations faster, cheaper and more efficient,” added Greenwich.

Reducing costs 

“TrueFX is the equivalent of an exchange with a matching engine, clearing house and FCMs,” Sandhu added. “However it is for over-the-counter trading with no central limit order book, and this is the first time this has happened.”

TrueFX is built on Integral’s existing ECN which is used by more than 200 financial services firms according to Sandhu. “We can easily extend our infrastructure to FX and provide cloud-based technology to the buy side at no cost,” he added.

Firms can trade with the same counterparties and use the same workflows on the new infrastructure.

Sandhu continued that two thirds of cost of trading FX is in clearing and settlement. “TrueFX can cut costs by between 60% to 80%,” he added.

TrueFX has been designed for the buy side including retail brokers, macro hedge funds, prime of primes and also regional banks. Sandhu said: “This is transformational for the buy side. We will be successful if TrueFX becomes their primary mechanism for trading FX.”

He continued that the higher costs had previously limited firms’ trading activity but now they have the opportunity to enter new markets and, by using a cleared venue, they can use their capital more efficiently.

“It will change way they manage risk as it is so much cheaper to execute small tickets,” Sandhu added.

Sandhu said that since the platform launched last year, firms have been inviting their counterparties to join TrueFX in order to lower costs for both. “We launched less than two and a half months ago and we are seeing the power of ecosystem,” Sandhu added.

However, Sandhu continued that the sell side is also interested in TrueFX as it lowers their distribution costs to the buy side. TrueFX has initially launched for trading spot FX but Sandhu said the platform could be extended to other products such as non-deliverable forwards.

“We are the equivalent of AWS, Amazon’s cloud computing services ,” he added. “Anyone who has an idea can launch an FX service on TrueFX.”

Electronification of FX

The share of notional FX trading volume executed electronically has hovered around 80% for the past several years according to Greenwich Associates.

The report said buy-side use of FX execution algorithms is also gaining traction. Greenwich added that in 2018, the use of algos increased by 25% to about one in five FX market participants.

“In a post-MiFID II environment, with increasing adoption of transaction cost analysis and advancements in technology – which in turn is augmenting better pre-and-post trade analytics – it is no surprise that adoption growth was led by real-money accounts, while hedge funds, the market’s earliest adopters, remain consistent users,” added the report. “At the same time, an increasing number of the most sophisticated corporates are also leveraging dealer algos to trade FX.”

Liquidity is building in the first dealer-to-client pure electronic central limit order book for interest rate swaps with trades increasing and 12 institutions preparing to onboard.

Trad-X, the platform for interest rate derivatives, launched the multi-lateral trading facility last month.

Dan Marcus, chief executive of Trad-X, told Markets Media that a central limit order book levels the playing field so everyone has equivalent access at the same price and the same levels of information, with no tiered pricing. Trad-X’s D2C venue provides an alternative to the traditional request for quote protocol and allows non-dealers to access pricing for a wide range of products from multiple dealers more quickly and cost effectively.

“This model provides a real alternative for buy-side clients when trading standardized products,” said Marcus.

Aegon Asset Management was the first buy-side institution to execute a euro interest rate swap on Trad-X’s D2C central limit order book. BNP Paribas was the counterparty, and the transaction was cleared by Deutsche Börse Group’s Eurex Clearing.

Derek Milner, senior portfolio manager at Aegon Asset Management, said in a statement: “Trad-X’s central order book for non-dealers lowers barriers to market entry and we are pleased to be the first institution to complete a trade with a dealer on the platform. We believe the main advantages of this platform are certainty of execution, anonymity and access to offsetting non-dealers’ exposures.”

Marcus continued that Trad-X’s D2C central limit order book had four market makers and five clients at launch, but this has since increased. The MTF has objective criteria to classify a participant as either a client or a dealer, not both. Dealers can only supply liquidity to clients and cannot trade with each other.

He said Commerzbank is the latest to join as a dealer, while DekaBank is a client.

“There are another 12 trading institutions in the onboarding process, so we expect liquidity to build,” Marcus added.

The institutions who will join in the coming weeks and months include tier 1 banks seeking to join as dealers, and non-dealers including small banks, hedge funds, asset managers and pension fund clients.

Market makers have an obligation to constantly stream prices to ensure that there is always a two-way price for clients to hit at any time of the day, or they can sit in the book with a passive bid/offer.

“Clients get immediate execution and central clearing through Eurex,” Marcus said. “We are in discussions with other CCPs to potentially extend our offering to them, as we embark on the next stage of growth.”

Volumes of trades are in double figures but Marcus continued that it is still very early days for the platform.

“We will have a better indication by the end of the first quarter whether the proof of concept works and where there is market appetite,” he said.

Clearing

Phillipe Dudon, chief operating officer at Trad-X, told Markets Media that direction of travel is clear in terms of the buy-side wanting cleared products.

In addition, the next phase of the uncleared margin rules is expected to lead to more demand for clearing. The next phase comes into force in September this year and more buy-side firms will be covered by the regulation which means they will have to exchange margin on uncleared derivatives contracts for the first time.

Phil Simons, global head fixed income sales – derivatives, funding & financing at Eurex, said in a statement: “It’s very encouraging to see platform initiatives such as Trad-X D2C CLOB gain momentum, as they are essential components in establishing Eurex as the home of the Euro across listed and over-the-counter derivatives. As well as enhancing execution options, this is consistent with our goal to help our members and clients reduce costs and increase efficiency through combining automated execution with integrated cross product clearing and collateral management.”

TRAD-X recently launched the first dealer-to-client pure electronic CLOB and completed several live transactions between dealers & non-dealers. Read about the implications for the market in these three questions to #EurexClearing’s Danny Chart: https://t.co/jaVfCJMovn #clearing

— Eurex (@EurexGroup) January 24, 2020

Dudon said Trad-X has built good relationships with the buy-side with regards to helping them move forward with their business.

“We have identified areas of possible expansion including a wider range of products, reporting and analytics,” he added.

He continued that the swap market is getting larger each year and needs more liquidity. “We expect this to be driven by electronic trading,” said Dudon.

The Bank of England is going to publish a new Sonia daily index and discourage the use of Libor-linked collateral to encourage the market to move away Libor to the new risk-free reference rate.

Andrew Hauser, executive director, markets at the Bank of England gave a keynote speech at the International Swaps and Derivatives Association/SIFMA Asset Management Group Benchmark Strategies Forum 2020 in London this morning.

Andrew Hauser ⁦@bankofengland⁩ delivers keynote address at Benchmark Strategies Forum ⁦@ISDAConferences⁩ ⁦@SIFMA⁩ pic.twitter.com/7L2k3d67dU

— ISDA (@ISDA) February 26, 2020

Hauser said: “2020 is a critical year for Libor transition. Great progress was made in 2019, particularly in sterling wholesale markets but there is still a lot of ground to cover – particularly in the cash markets.”

After the financial crisis there were a series of scandals regarding banks manipulating their submissions for setting benchmarks across asset classes, which led to a lack of confidence and threatened participation in the related markets. As a result, regulators have increased their supervision of benchmarks and want to move to risk-free reference rates (RFR) based on transactions, so they are harder to manipulate and more representative of the market.

The UK has chosen the sterling overnight index average, Sonia, as its risk-free rate. The UK Financial Conduct Authority said two years ago that it will not compel panel banks to submit to Libor beyond 2021.

Sonia compounded index

In order to boost the transition from Libor the UK central bank intends to publish a daily Sonia compounded index.

“This would support the use of Sonia in as wide a range of financial products as possible by simplifying the calculation of compounded interest rates,” Hauser added.

In his speech today Andrew Hauser, Executive Director, Markets, announces two of our new initiatives aimed at supporting the transition away from LIBOR. https://t.co/qWWLl27o6E pic.twitter.com/1sXhMY2QVp

— Bank of England (@bankofengland) February 26, 2020

The Bank of England is also considering publishing a set of compounded Sonia period averages and is consulting with the  market on the preferred conventions which will be used.

“We hope that, in time, this tool will complement others already available, helping to build further momentum for LIBOR transition in sterling cash markets – supporting both end-users and loan and infrastructure providers,” Hauser added. “But these firms should not wait for the index before undertaking their own broader preparations.”

Libor-linked collateral

In addition, the Bank of England will begin increasing haircuts on Libor-linked collateral it lends against from October this year. A haircut protects against possible falls in the value of the collateral  in the time between a counterparty default and collateral sale, including in times of potentially severe stress.

“Haircuts are scheduled to reach 100% (i.e. implying effective ineligibility) at the end of 2021,” he said. “These initiatives are aimed at turbo-charging sterling transition, helping the market deliver against its commitment to transition away from Libor and further de-risking sterling markets.”

Approximately one tenth of banks’ drawing capacity is collateralised by assets referencing sterling Libor such as securities paying a Libor-linked coupon.

“The risk is that, absent appropriate planning, these assets could become increasingly difficult for the Bank to value, risk manage and service as Libor cessation approaches,” said Hauser.

He continued that the Bank’s Risk Free Rate Working Group, under the leadership of Barclays’ chief financial officer Tushar Morzaria, has set a road map for the transition with the latest version released last month.

“Amongst many important milestones on that map, the most important is to cease issuance of term sterling Libor-linked cash products by the third quarter of 2020,” Hauser added.

Progress has been in the sterling derivatives market with approximately half of new cleared sterling swaps referencing Sonia last year.

The switch to SONIA is happening right across the curve, says Michael Barron @DeutscheBank. Almost 100% of real money activity in swaps is in SONIA. New LIBOR activity is mostly as a result of managing legacy positions or hedging parts of the market that are harder to transition

— ISDA (@ISDA) February 26, 2020

In addition the Bank and FCA have encouraged market makers to use Sonia as the standard reference rate for sterling interest rate swaps from 2 March 2020.

March 2 is the chosen date for a convention change in sterling swap markets – it doesn’t mean no new LIBOR swaps yet, but it does mean quoting SONIA swaps rather than LIBOR swaps will become the norm, says Edwin Schooling Latter @TheFCA @ISDAConferences @SIFMA

— ISDA (@ISDA) February 26, 2020

Although there has been progress in the swaps market, Sonia also needs to be increasingly used in futures and non-linear products.

“In preparation for the provision of a robust forward-looking sterling term rate, many banks are now streaming executable Sonia swap prices to regulated trading venues,” said Hauser. “Having the inter-dealer market able to trade Sonia in a single click is a key building block to helping firms hedge with the smallest friction possible.”

The Bank’s working group will be considering what more needs to be done to drive transition in these markets over the coming months.

Poll : 58% not prepared for discounting switch by CCPs to SOFR in October https://t.co/4AxcvsJa5j

— Shanny Basar (@shannybasar) February 26, 2020

Market participants are at different stages, but the larger banks are pretty well advanced in terms of analysing LIBOR risks in their books. The situation at smaller institutions and corporations is more varied, says Alan Farrell at @GoldmanSachs @ISDAConferences @SIFMA

— ISDA (@ISDA) February 26, 2020

Reimagining the Role of the CFO in The New Decade

By Susan Cosgrove, CFO, The Depository Trust and Clearing Corporation (DTCC)

As we start this new decade, chief financial officers are primed to take on expanded strategic responsibilities as Boards of Directors and senior leaders look to them to help lead the business forward. CFOs have the opportunity to grow our influence by helping to define the future vision of our organizations – and central to this is our ability to become champions of innovation.

For some CFOs, this role can feel at odds with our traditional mandate as financial stewards. That’s not surprising because innovation is difficult to define or quantify in financial terms and often unmoored  from certain financial return. As we’ve seen over the past few years, the innovation dynamic can change rapidly and unexpectedly – for better and worse.

But at a time when companies are focused on remaining competitive and relevant in a hyper-dynamic marketplace, I believe CFOs actually are  in the strongest  position to help our organizations find that vital balance between innovation and safe financial decision-making. No other executive has the unique enterprise-wide view that we have. Based on my experience, these are the three key themes we need to follow to be successful.

CFOs Are Leaders of Innovation

A long-time and mostly unfair perception exists that CFOs are unmoving gatekeepers of experimentation and  roadblocks to new ideas. This couldn’t be further from the truth, although there are times we do need to say “no.” In most cases, however, CFOs are the lynchpin that supports innovation by connecting investments to outcomes and outcomes to growth and an improved client experience. We may operate in a seemingly black-and-white world of balance sheets, finite resources and budget constraints, but  that actually provides the foundation for inspiration and innovation.

Creativity doesn’t stem from unlimited resources, but rather from the resourcefulness of what is available and the ingenuity of employees who serve on the front lines. CFOs evaluate progress and direct funding to the initiatives with the greatest demonstrated potential, using checkpoints and guardrails to make decisions whether to speed up development or fail fast.

While popular culture likes to promote the notion of the “eureka” moment in the innovation process – as  if it always occurs spontaneously and independently – the reality is that discovery doesn’t occur or thrive in a vacuum. What truly drives the brightest ideas is an operating model and corporate culture that is proactive and fosters collaboration and constructive engagement among teams.  Here, too, CFOs are uniquely placed to help create that environment, using our vantage point at the center of the organization to understand which areas are regularly succeeding and why. Armed with this insight, we can encourage those behaviors more broadly across the entire firm.

Parameters, not rules

As CFOs, our world consists of numbers, data and metrics to execute actions. We are instinctively drawn to trendlines and extrapolating data for forecasting. Usually, we tend to be biased toward the certainty of past successes, using it to inform future decision-making.

But that’s only half the story because very often failures provide valuable lessons. Innovation flourishes through the iterative process of trying, learning, not succeeding and then achieving. CFOs  support this by helping to create the appropriate sandbox for experimentation, bordered by KPIs and other cold, hard facts as guardrails,  while creativity and freedom build sand castles  on inside.

The fundamental goal of every CFO is to ensure the prosperity of their firm by achieving financial growth and avoiding financial disaster. As CFOs, we can tip the scales toward the former by establishing a framework for selecting and prioritizing projects, predicting their respective risk, creating a balanced ‘portfolio of innovation initiatives,’ measuring their performance and assessing their impact on the firm.

Focusing on the Long-Term

CFOs face enormous short-term pressures, but our jobs don’t stop at the end of a quarter or calendar year. Those are merely chapters in a much longer story in the life of an organization. While we need to be ever-mindful of today, CFOs must  look beyond the horizon and help enact policies in their organizations’ long-term best interest. For example, we can accelerate or moderate the pace of innovation to correspond to market trends, leveraging data, analytics and other indicators to direct investments that will produce sustainable results over many years.

The ability to see past immediate financial deadlines is crucial for the modern CFO to help innovation thrive at their firms. After all, innovation doesn’t follow schedules. It’s better to take the mindset of experimentation even though it can require patience and longer timelines to see results.

While a CFO’s “day job” may be governed by target dates, it’s our responsibility to look beyond those and track progress, not completion. And most important, we need to be front-and-center in celebrating the successes and learning from the failures to encourage a culture of discovery.

As more is expected of CFOs in the years ahead, having the opportunity to play a bigger role in setting a vision and helping drive long-term success at our firms will complement the role we already play in protecting the financial health of our organizations.

Susan Cosgrove is Managing Director and Chief Financial Officer for The Depository Trust & Clearing Corporation.

The Global Impact of Settlement Discipline Regulation – Ensuring U.S. Firms are prepared

By Matt Stauffer, DTCC Managing Director, Head of Institutional Trade Processing

Although it is now more than 10 years since the G20 Summit in Pittsburgh, where policy makers agreed that post-crisis regulation should focus on increasing transparency and mitigating systemic risk in the global financial markets, there are still new impacts coming to the marketplace. While most European post-crisis regulation has long been implemented, such as the European Markets Infrastructure Regulation (EMIR) and Markets in Financial Instruments Directive (MiFID II), February 2021 will see the Settlement Disciple Regulation (SDR) come into force, which is the final and most significant phase to impact post trade of the Central Securities Depository Regulation (CSDR).

The purpose of SDR is to reduce risk by increasing settlement efficiency across European markets. The regulation aims to raise settlement rates in Europe from approximately 97.5% to more than 99%. This target has not been explicitly stated in the legislation or any of its accompanying documentation, probably because currently there is no official data quantifying settlement rates for the region as a whole. The Central Securities Depositories (CSD) market in Europe is not homogenous and there are over 40 CSDs that use different definitions and methodologies to determine settlement efficiencies. However, SDR’s overarching policy objective is for settlement efficiency rates to match those achieved in the U.S. market.

With that in mind, how prepared is the global market for the implementation of SDR? Most European firms are aware of the regulation and are getting ready. However, while the regulation was conceived in Europe, its impact will be felt by any market participant, buy-side or sell-side, that invests in the European market, regardless of where they are domiciled, just like under MiFID II. This means that the extra-territorial reach of the regulation is determined by where the settlement of the stock takes place – if a stock is bought within any EU 28 country and is settled in an EU 28 central securities depository (CSD), the regulation will apply.

This brings communications challenges that are also reminiscent of MiFID II – namely, that there are many US buy-side and smaller sell-side firms that are unaware that they are in scope of SDR. Up until just one day before the MiFID II implementation deadline, thousands of U.S. financial institutions were not aware that they were in scope of the regulation.  Further, for some buy-side firms that were aware of their compliance obligations, there was an assumption that their broker would manage it on their behalf. That assumption remains false for SDR – firms should not assume that their broker will take care of compliance.

So, what penalties will U.S. firms which are not ready for SDR face? For trades which fail to settle under the mandated T+2 timeframe – an earlier component of CSDR which came into force in 2014 – market participants will be liable to pay penalties or charges against each transaction. A penalty will be charged daily based on the asset class/security type and notional value of the transaction, up until the buy-in process is initiated. The buy-in process in itself will present firms with an administrative burden – a mandatory process will be required to take place for any financial instrument which has not been delivered within a specified period of the intended settlement date in order to fulfil settlement. This period will vary depending on the type of security – illiquid assets will need to be brought-in with seven days of the intended settlement date, while more liquid products such as equities and bonds will be required within four days. Small to medium-sized stocks will be subject to a buy-in 15 days after the intended settlement date and while this appears to be more flexible, as these types of transactions are difficult to borrow, market participants could be subject to 15 days of failed trade penalties, an outcome that would prove very costly.

The most effective way for in-scope U.S. firms to prepare for SDR and avoid financial penalties and costly buy-ins is to analyze the reasons for failed trades. Usually, failures are the result of manual processing and therefore, market participants should focus on automating the post-trade process and leveraging standardized protocols, such as using validated SSI’s, automated trade confirmation and matching and leveraging additional data sources such as place of settlement and Legal Entity Identifiers (LEIs) into their post trade process. Not only will this approach help market participants to reduce failed trades and hence assist in complying with a key component of SDR, implementing best practice back office solutions such as central matching, will create wider benefits such as increasing operational efficiency and risk mitigation.

The U.S. Securities and Exchange Commission hit a straight shot down the fairway.

The regulator’s Feb. 14 proposal to modernize the data infrastructure that underpins institutional trading has been generally well-received by market participants, who note among other things that the plan would bring much-needed improvements to the Securities Information Processor, the industry data utility.  

“The recent proposals are an appropriate step in the effort to modernize the regulation of equity market data and address industry concerns related to content, latency and governance,” said Mehmet Kinak, Global Head of Systematic Trading and Market Structure at T. Rowe Price.  

But, some market reactions have been tempered by the view that the SEC plan, if implemented as outlined, would fall short of truly changing the dynamic in what has been a battleground for years.

“The proposal would expand the information provided by the public market data stream to include things that nearly everyone should agree must be included, like auction information, odd-lot orders, and depth-of-book information,” said Tyler Gellasch, Executive Director of industry trade group Healthy Markets. “That’s a huge step forward.” 

“The competitive part of the proposal would dramatically reduce latency between the SIP and the private data feeds sold directly by the exchanges. But, it would not eliminate latency,” Gellasch said. “Structurally, the exchanges would still have a temporal advantage over third-party data providers. Traders who want the data the fastest are still going to have to buy it directly from the exchange.” 

Backstory

Data wars pitting brokers against exchanges have been a long-simmering industry saga that boils to the surface in conference panel discussions and comment letters. In short, brokers say the SIP is hopelessly antiquated and unusable, and the price of exchange data feeds is onerous; exchanges say data prices fairly reflect their own high costs, and brokers and traders have choice in data products.    

The SEC, which noted it hasn’t “significantly updated” its data rules since the late 1970s, is taking a two-pronged approach to fix things: upgrading the National Market Structure (NMS) data as disseminated via the SIP, and decentralizing the SIP function to allow for competing data consolidators. 

“As a buy-side firm and fiduciary, it is important to us that our broker-dealers have the fastest and deepest possible information for a full and accurate view of the market,” Kinak said. “Practically speaking, however, broker-dealers do not have the option to forego buying proprietary data because the lower-priced information provided by the SIPs is not as expansive and the SIP feeds are slower.”

“The SEC proposals attempt to address the product and performance differentials between the SIPs and proprietary data feeds,” Kinak continued. “Additionally, broadening the SIP’s operating committee representation by including non-SRO members will encourage additional competition and transparency within the market data framework.”

Trading-technology provider Clearpool Group has been vocal about the need for a rethink of the market’s data infrastructure, especially regarding shortcomings of the SIP and a lack of transparency overall. Clearpool CEO Joe Wald said the SEC proposal means the dialogue around data is now out in the open, “out of the hallway and into everybody’s living room.”

“The SEC proposal is a bold step forward — it’s not perfect, but it’s a start,” Wald said. “We do see challenges. Does the potential for conflict of interest still exist with respect to how this plan is controlled? Taking a look at the governance model, will it work with respect to how votes are split? We welcome the involvement of participants other than SROs, but is this the right model to effect change, or does this create a potential for deadlock?” 

For their part, exchange operators recognize that data-infrastructure evolution is inevitable, and they have been active voices in the debate. Nasdaq last year proposed SIP reforms that would create more efficiency, choice, and industry participation in the data utility, and the firm also increased information disclosure around its market data revenues.    

Regarding the SEC’s Feb. 14 proposal, a NYSE spokesperson told Markets Media: “NYSE supports enhancing the current system for consolidated market data, and the proposal shares many elements with NYSE’s recent comment letter calling for SEC rulemaking to expand its content and modernize its delivery.”

First Swing

The SEC’s first swing at data-infrastructure modernization was a reasonable one, market participants say — it didn’t make the green, but neither was it a slice into the woods. Next up is a 60-day comment period likely followed by a second swing in the form of an updated iteration of the proposal.  

“Ultimately, the main question that needs to be answered is whether the SIP will be a viable alternative” to exchange data feeds, Clearpool’s Wald said. “Will it be accepted by market participants for best execution, and will it be accepted for use from a regulatory perspective?”

The UK Financial Conduct Authority included the transition from Libor as one of its four priorities this year in its supervision of wholesale financial markets.

The FCA said in a report, Sector Views 2020, that four priority themes in wholesale markets are Libor transition, operational resilience, market abuse and financial crime.

The regulator, led by interim chief executive Christopher Woolard, said the transition from Libor has progressed, but there is more to do.

Christopher Woolard on today's Sector Views publication pic.twitter.com/7ps5gEd4Rr

— Financial Conduct Authority (@TheFCA) February 18, 2020

“Transition from Libor to alternative risk-free rates should, in the long-run, increase market integrity,” added the FCA. “But we are still concerned that the potential for a disorderly transition could lead to harm.”

After the financial crisis there were a series of scandals regarding banks manipulating their submissions for setting benchmarks across asset classes, which led to a lack of confidence and threatened participation in the related markets. As a result, regulators have increased their supervision of benchmarks and want to move to risk-free reference rates (RFR) based on transactions, so they are harder to manipulate and more representative of the market. The UK has chosen the sterling overnight index average, Sonia, as its risk-free rate.

The FCA said two years ago that it will not compel panel banks to submit to Libor beyond 2021. However, the report noted that a large number of contracts and systems need updating before the end of next year when Libor is expected to stop. For example, at the end of August last year there was more than £25($32) trillion of outstanding notional in cleared sterling Libor derivatives, with half maturing beyond the end of 2021.

“Some markets have made good progress, but Libor is still used heavily, including in new contracts in some markets,” said the FCA. “We continue to work closely with market participants and other authorities to support the transition effort”

There is also potential for a disorderly transition from Libor in investment management, which could result in significant harm, according to the FCA. The report cited a survey from the Investment Association which found that 40% of asset manager respondents said that client Libor exposures increased in 2018 while 45% said they decreased.

“Transition cuts across investment and hedging products, fund and manager benchmarks, critical risk management and many middle and back office processes,” added the study. “It also affects key oversight functions, such as authorised fund managers and depositaries.”

The FCA also highlighted that firms in the retail market need to take action as more than 200,000 mortgage contracts are linked to Libor.

“Firms need to consider how their contracts will operate when Libor no longer exists, and whether the terms allow the contract to be moved to an alternative benchmark,” sad the report. “A small number of firms are still offering Libor-linked mortgages. We are monitoring this issue closely.”

RFR trading

Trading volumes of RFR derivatives hit record volumes last month according to a blog by Chris Barnes at analytics provider Clarus Financial Technology, showing there is some progress in the transition from Libor.

Trading RFRs https://t.co/8SQV3ZMZLH pic.twitter.com/pWvKtB3Noh

— Clarus (@clarusft) February 19, 2020

However the data showed that RFR trading continues to be dominated by activity in the short maturities.

“For example, the tenor profile of GBP Sonia trading is very much dominated by tenors shorter than two years,” added Barnes.

Amir Khwaja, chief executive of Clarus, said in a blog that interest rate swap trading is still dominated by Libor, rather than Sonia, notional for trades maturing after the start of 2022.

Spotlight on RFR Swaps https://t.co/vYslgI6V8N pic.twitter.com/BgAOAxEd2V

— Clarus (@clarusft) February 18, 2020

Khwaja continued that it will be interesting to see how Sonia volumes develop as sterling Libor is due to stop trading on 2 March. Last month the FCA and the Bank of England said  market makers should change sterling interest rate swaps from Libor to Sonia in the first quarter of this year.

Edwin Schooling Latter, director of markets and wholesale policy at the FCA, said in a statement: “I encourage all market participants to join the initiative to put Sonia first over Libor from 2 March. This should help make Sonia the market standard in sterling swaps as is already the case in the bond market.”

Khwaja said it is a very tall order to see a massive shift in volumes in two weeks.

“More time will be needed and possibly we also need to wait for term rates in Sonia to become available, which a few firms are competing to publish,” added Khwaja.