LIBOR's Demise Will Up-end Derivatives

CME Group Inc. shed light on what could happen to the exchange giant’s most-traded contracts—eurodollars, which permit bets on interest rates—if the scandal-plagued LIBOR benchmark they’re tied to goes away in two years.

Officials at CME on Tuesday proposed a methodology for converting eurodollar futures and options to other derivatives at the exchange, ones linked to an alternative benchmark called the Secured Overnight Financing Rate, or SOFR. The plan could be tweaked based on customer feedback.

In 2021, the U.K. regulator that oversees LIBOR, the Financial Conduct Authority (FCA), will stop compelling banks to submit data used to calculate LIBOR. CME CEO Terry Duffy said in an October interview that the benchmark isn’t guaranteed to go away then. But LIBOR is so deeply embedded in the global financial system that even a slim chance it disappears means contingency planning is necessary.

On a Tuesday webinar, CME officials Sunil Cutinho and Agha Mirza addressed the question of what would happen if there were a “fallback trigger,” meaning the FCA or ICE Benchmark Administration (the company that maintains LIBOR) said the index wouldn’t be provided anymore. In that case, eurodollar futures would be turned into SOFR futures, converted to the same month’s expiration at a price determined by the pre-fallback eurodollar price plus a spread adjustment.

Eurodollar options would continue to be listed because converting them “would result in nonstandard strike prices different to the standard listed strike prices” for SOFR options, Cutinho said. However, upon exercise, the resulting “synthetic” eurodollar futures contract would convert immediately into a corresponding SOFR futures contract.

“Without a fallback trigger, the eurodollar complex will remain unchanged,” Mirza said. “Eurodollar futures and options remain deeply liquid and continue to grow year after year.”

The stakes are high for CME, given that eurodollar futures are the most-traded interest-rate derivatives tracked by the Futures Industry Association. Almost 380 million of them changed hands during the first half of this year, according to the trade group. LIBOR is currently used to settle $67 trillion in listed products, including eurodollar futures and options, Cutinho said.

CME plans to offer customers support in converting their eurodollar options to SOFR options, which are slated to debut on January 6, Cutinho and Mirza said. Also, in the event of a fallback trigger, CME would immediately create new contracts to fill in any gaps where there are eurodollar expirations but not corresponding ones for SOFR.

CME’s proposed methodology aligns with the International Swaps and Derivatives Association’s (ISDA’s) proposed methodology for settling swaps in the event that LIBOR production ceases, exchange officials said.

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