- February 2021 saw 10.6% of all derivatives risk traded versus an RFR.
- This has now been stable around 10% for some time.
- We cover the pre-cessation announcements concerning LIBOR and the historic here, and Butterflies and Switches here.” class=”glossaryLink ” target=”_blank”>spread calibration that took place last week.
- There has also been a sharp move higher in the amount of long-dated SONIA risk being traded.
- The change in market composition for SONIA markets is exactly the type of change the Indicators are designed to monitor.
- We are now expecting these changes across all of the currencies subject to LIBOR pre-cessation announcements (CHF, JPY and USD we are talking about you!).
The latest ISDA-Clarus RFR Adoption Indicator has just been published for February 2021. It saw a small increase, but has been stable around 10% for a few months.
- The overall Adoption Indicator was at 10.6%, marginally higher than the 10.0% readings of the prior two months.
The BIG News is the LIBOR pre-cessation announcement
The RFR Adoption Indicator published today is based upon February 2021 trading data. This means that the data does not yet take into account the impact of the LIBOR pre-cessation announcement that occurred on Friday March 5th.
Talking of which, let’s run through what happened on Friday:
|USD1M||11.448 basis points|
Overall, we have now moved into a world where a lot of “known unknowns” have now become “known knowns“. With the exact calibration of the historic spreads, firms can make an accurate judgement as to whether restructuring or relying on Fallbacks is preferable.
It will be important over the coming months to stay on top of the data to see what trends now follow. Restructuring or relying on Fallbacks? Stay tuned to find out.
First, a summary of February 2021.
ISDA-Clarus RFR Adoption Indicator at 10.6%
- Following on from the pre-cessation announcements on Friday, it is worth dwelling on the fact that only around 10% of all of the derivatives Rates risk transacted is currently versus a Risk Free Rate. The rest was transacted versus legacy rates, mainly LIBORs which are now known to cease at the end of this year (or 2023 for USD).
- February 2021 was generally a big month for interest rate risk traded. The broad sell-off in Fixed Income contributed to this, as we saw for USD markets in last week’s blog. This was reflected across our indicator data, where large amounts of risk (and notional) were traded in both RFRs and legacy rates.
- For the fourth month running, ~5% of total USD risk was transacted versus SOFR. Four months in a row now!
- CHF SARON markets reached a new high at 8.5% whilst JPY TONA is still down at 3.5%. The low level of activity in these two currencies is concerning from a transition perspective (as we highlighted in our response to the IBA LIBOR consultation).
GBP SONIA Shows the Biggest Moves
We argued in our IBA consultation response that it would probably take regulatory action to significantly increase the amount of RFR trading. The action taken in the UK, with the FCA setting out the roadmap for benchmark reform and requesting for the interbank standard to move to SONIA, certainly seems to be taking effect.
For GBP markets, this is best shown by the increase in long-dated SONIA activity. First, the amount of SONIA notional traded in tenors longer than 2Y hit a new record by a huge amount:
And secondly, there was more long-dated SONIA traded than LIBOR, in notional terms during February 2021:
These are the real signs of benchmark reform that we have been looking for from these indicators and is a very positive sign.
SOFR Saw A Small Increase
As Amir noted, we saw some records in cleared OTC SOFR risk in February 2021. The DV01 data doesn’t reveal much more, other than the fact that the small drop-off in SOFR futures activity somewhat offset the (larger) increase we saw in OTC SOFR risk traded.
However, the increases in LIBOR trading seen in USD markets more than offset this small increase in SOFR risk traded, hence a lower percentage overall was transacted in SOFR this month than last.
- The long awaited pre-cessation announcements for LIBOR actually happened last week!
- These announcements may fundamentally change the level of the ISDA-Clarus RFR Adoption Indicators from next month.
- We have already seen regulatory action such as this take effect on the SONIA market.
- SONIA is now the most widely traded index in GBP Rates markets, and now makes up the majority of trading in long-dated derivatives.
- SONIA is now THE benchmark for GBP derivatives.
If there’s one message from this blog it is that we are waiting to see SONIA-esque moves in long-dated risk for CHF, JPY and eventually USD!
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Aite survey: Financial institutions will invest more to automate loan process
Financial institutions plan to increase their spend on automations and collections management solutions for their loan processes. Fresh results on consumer lending practice from research and advisory firm Aite Group indicate lenders plan to invest more heavily in their collections processes, said Leslie Parrish, senior analyst for the Aite Group’s consumer lending practice. Parrish shared […]
Facial recognition, other ‘risky’ AI set for constraints in EU
Facial recognition and other high-risk artificial intelligence applications will face strict constraints under new rules unveiled by the European Union that threaten hefty fines for companies that don’t comply.
The European Commission, the bloc’s executive body, proposed measures on Wednesday that would ban certain AI applications in the EU, including those that exploit vulnerable groups, deploy subliminal techniques or score people’s social behavior.
The use of facial recognition and other real-time remote biometric identification systems by law enforcement would also be prohibited, unless used to prevent a terror attack, find missing children or tackle other public security emergencies.
Facial recognition is a particularly controversial form of AI. Civil liberties groups warn of the dangers of discrimination or mistaken identities when law enforcement uses the technology, which sometimes misidentifies women and people with darker skin tones. Digital rights group EDRI has warned against loopholes for public security exceptions use of the technology.
Other high-risk applications that could endanger people’s safety or legal status—such as self-driving cars, employment or asylum decisions — would have to undergo checks of their systems before deployment and face other strict obligations.
The measures are the latest attempt by the bloc to leverage the power of its vast, developed market to set global standards that companies around the world are forced to follow, much like with its General Data Protection Regulation.
The U.S. and China are home to the biggest commercial AI companies — Google and Microsoft Corp., Beijing-based Baidu, and Shenzhen-based Tencent — but if they want to sell to Europe’s consumers or businesses, they may be forced to overhaul operations.
- Fines of 6% of revenue are foreseen for companies that don’t comply with bans or data requirements
- Smaller fines are foreseen for companies that don’t comply with other requirements spelled out in the new rules
- Legislation applies both to developers and users of high-risk AI systems
- Providers of risky AI must subject it to a conformity assessment before deployment
- Other obligations for high-risk AI includes use of high quality datasets, ensuring traceability of results, and human oversight to minimize risk
- The criteria for ‘high-risk’ applications includes intended purpose, the number of potentially affected people, and the irreversibility of harm
- AI applications with minimal risk such as AI-enabled video games or spam filters are not subject to the new rules
- National market surveillance authorities will enforce the new rules
- EU to establish European board of regulators to ensure harmonized enforcement of regulation across Europe
- Rules would still need approval by the European Parliament and the bloc’s member states before becoming law, a process that can take years
—Natalia Drozdiak (Bloomberg Mercury)
What banks are looking for after COVID-19
As the number of vaccinated adults in the United States grows and the average rates of COVID-19 infections drops, bankers and their customers are eager to move ahead. But what does “move ahead” look like, and how has consumer demand changed over the course of the past year?
To answer this question, we at MX surveyed 1,000 randomly selected U.S. consumers with results published in our ultimate guides. Among many insights, we found that 87% of consumers say they now visit their bank branch less often than they did before the COVID-19 pandemic, while 89% say they use mobile banking more often. We also found that a quarter of respondents said they’d currently feel insecure about their financial situation if they hadn’t received a third stimulus check, while half said that without the stimulus check they’d struggle to cover their monthly living expenses such as rent, mortgage, and recurring bills.
In other words, consumer demand for digital banking has surged at the same time that consumers have received an influx of stimulus cash — a shift that puts banks in a bit of a bind. As covered in an article from Bloomberg Opinion columnist Brian Chappatta, banks now face the largest gap in decades between a typical bank’s deposits at hand (which are high) and the demand for new loans (which is low). Given this gap, Chappatta writes, “In the near future, [banks] may need to rely even more heavily on revenue outside of their traditional business of making loans.”
Banks looking for these new revenue models in the wake of COVID-19 should know that the way forward must be digital first.
One possibility worth exploring is a subscription service, possibly in the vein of Amazon Prime. As Bradley Leimer, co-founder of Unconventional Ventures, says, “If banks can’t offer something more valuable than Amazon Prime, then we’re probably in the wrong business. I think we just need to retool our mindsets and put the customer at the heart of these decisions. What is at stake, in my opinion, is literally the future of the financial services model. The wolves are at the door.”
In light of this, financial institutions can ask themselves which benefits they offer could be packaged together for a monthly subscription. For example, Utah Community Credit Union (UCCU) has developed a product called UCCU Prime, which gives members services including $600 per claim in cell phone protection in the event their phone is broken or stolen, $80 in coverage for roadside assistance (4x a year), a $10,000 reimbursement in expenses in the event of stolen identity, $10,000 travel accidental death coverage, special deals for local businesses, travel discounts nationwide, debit card rewards, and more — all for $6 a month. As UCCU creates new offerings, they can add them to the bundle and increase this revenue stream.
This is just one of many possibilities that comes with looking at banking with a new pair of eyes as we work to put COVID-19 behind us and explore new revenue streams.
The Impact of COVID-19 on Capital Markets Operations
The Depository Trust & Clearing Corporation (DTCC), the premier market infrastructure for the global financial services industry, today published a white paper examining how capital markets operations responded during the COVID-19 pandemic and where market participants are focused in a post-pandemic future.
In a new white paper, “Managing through a Pandemic: The Impact of COVID-19 on Capital Markets Operations”, buy and sell-side firms reported that, while their post-trade operations (Ops) and operations technology (OpsTech) proved largely resilient during the pandemic, several key challenges emerged as market volatility surged throughout 2020. The study was conducted with research assistance from McKinsey & Company, and was based on insights from Ops and OpsTech professionals at 35 buy and sell-side firms. The top areas of focus highlighted were:
- Cash fixed income and cash equities were most impacted by the pandemic-induced market volatility, with 30-35% of firms across the buy-side and the sell-side reporting operational post-trade processing challenges in these asset classes.
- From a processing perspective, settlements/payments and collateral/valuations were impacted the most, with 58% of sell-side firms reporting challenges in settlement and payments during the peak of the pandemic.
- Buy-side firms typically experienced less disruption to post-trade processes than sell-side firms due to simpler operational models, with the sell-side reconciling breaks and settling trades across hundreds of counterparties.
- The sudden transition to a work-from-home operating model was achieved almost seamlessly, and in most cases within a matter of days, due to the ability to implement tactical changes to operating models.
Respondents cited that efforts made in recent years to re-engineer and automate processes and upgrade technology platforms were the main reason for firms’ resilience during the pandemic and their ability to manage an unusually prolonged business-continuity planning (BCP) event. A significant majority of respondents stated that the pandemic validated their Ops priorities and investment plans.
Michael Bodson, President & CEO at DTCC, said, “During, and in the immediate aftermath of the COVID-19 pandemic, the industry remained resilient, with buy and sell-side firms working seamlessly to support unprecedented volumes and ensure uninterrupted trading for clients and underlying investors. However, opportunities remain for further optimizing post-trade processes across the capital markets.”
The survey highlighted that while the pandemic did not create an impetus for change in Ops and OpsTech due to largely resilient operations, a consensus emerged around where firms should focus next:
- Sell-side and buy-side firms are aligned on the need to further simplify and standardize a sub-set of post-trade services which were hardest hit. For the sell-side, these include making enhancements to reconciliations and confirmations capabilities, while the buy-side prioritized an increased focus on fails and collateral management.
- More than half of firms who responded to the survey plan to increase capacity, build new capabilities or re-engineer post-trade processes.
- Respondents highlighted the need for a continued focus on shortening settlement cycles due to the impact of the unprecedented trading volumes and volatility on liquidity and margin. More than 50% of firms plan to increase capacity in support of these processes.
- The stigma around working from home and productivity no longer exists, with many firms planning to retain part of the remote and flexible working model post-pandemic across post-trade operations.
Bodson added, “As the impact of the pandemic continues to unfold, firms must keep their focus on delivering continued improvements to efficiency, while reducing risk. At the same time, to unlock new sources of value and remain relevant to clients, a focus on innovation will be essential. The industry will need to embrace collaborative approaches, common processes, best practices and deploy operating models that continue to meet the evolving needs of market participants.”
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