LIBOR Chicken and Egg
Lack of volume in derivatives tied to other benchmarks is driving many asset managers, traders, and corporate treasurers to continue using LIBOR-based derivatives.
It’s one of the most confounding questions facing regulators in the fight to phase out the London interbank offered rate (LIBOR): How do you wean everyone from asset managers and traders to corporate treasurers off derivatives that are so ubiquitous, they’ve become part of the fabric of the financial system?
For the better part of three years, U.S. officials have been preaching patience. LIBOR-based interest-rate swaps, futures, and options—among the most liquid markets in the world—would gradually give way to new securities tied to new benchmarks, they said, including the Secured Overnight Financing Rate (SOFR), anointed successor to dollar LIBOR.
Yet activity in those markets isn’t disappearing. What’s more, acceptance of alternative products has been slow. While some headway has been made, average open interest in three-month SOFR futures barely topped 5 percent that of eurodollar contracts last month. And recent high-profile milestones in the LIBOR transition that were expected to jumpstart trading in the new instruments have delivered relatively modest boosts so far.
As the Federal Reserve’s year-end deadline to halt new LIBOR contracts creeps closer, some are beginning to express concern that the slow pace of progress could undermine efforts to ensure a smooth transition, posing a risk to financial stability. While few expect a delay similar to the one announced in November for legacy contracts that can’t be shifted to SOFR, it’s another example of the difficulties regulators have had in getting critical corners of the financial world on board.
“We’re in this classic chicken-and-egg scenario, where participants don’t want to trade because liquidity is low, but there’s not going to be enough liquidity unless people trade it,” Thomas Pluta, global head of linear rates at JPMorgan Securities, said of SOFR derivatives. “It’s increasing, but quite frankly there’s an awful lot more that needs to be done for this transition to happen.”
See also:
- $345 Billion LIBOR Dilemma
- A Guide to the World’s Post-LIBOR Benchmarks
- Showdown in the LIBOR Corral
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