By Helen Bartholomew
LONDON, Oct 24 (IFR) - CurveGlobal, the London Stock Exchange Group’s fixed income derivatives platform, plans to launch futures contracts referencing the Sterling Overnight Index Average, a Bank of England-administered unsecured lending rate that has been selected as the preferred Libor replacement for sterling financial contracts.
The new futures, expected to begin trading in 2018, would be the first in an expected range of contracts linked to alternative risk-free rates as regulators around the world aim to reduce reliance on Libor, which serves as a reference point for more than US$350trn of loans and derivatives.
“We will launch something in this space next year and plan to offer futures on a number of rates, potentially one per currency,” said Andrew Ross, CEO of CurveGlobal. “The Bank of England have a clear plan to move the market away from Libor and we are in the perfect position to launch innovative products based on the new rates to support this.”
A Bank of England working group earlier this year selected Sonia as the preferred short-term interest rate benchmark to replace Libor following a widespread rate-rigging scandal that brought the benchmark into disrepute and left submitting banks facing billions of dollars in regulatory fines.
The BoE is leading a reform effort for Sonia, which will see a broader range of unsecured overnight loans included in the calculation, with the new-look rate set to be published from April 2018.
CurveGlobal is now finalising a series of futures based on feedback from trading houses, clients and asset managers in response to the findings of the BoE working group.
“We’re at the point where we have a series of contract specs that we’re reviewing internally with the IT groups and are seeking advice and thoughts of market participants,” said Ross. “We’re responsive to our customer demand, we’re not telling our customers what to trade.”
The exchange will attempt to gain critical mass with a limited range of tenors before developing a full curve. That will be crucial if backward-looking overnight rates are to become relevant in a market currently tied to three-month Libor - a forward looking measure.
“One of the challenges is what you start with,” said Ross. “When you launch a new product range you’ve got to pick a relatively small sweet spot to start the build with. We’re collaborating with the market on that.”
Contracts on additional rates will be developed as regulators settle on preferred alternatives. European regulators are yet to agree on a replacement for Euribor in euro-denominated contracts. Eonia was originally perceived as a likely candidate, but a slump in unsecured lending used to determine the rate raised questions around its robustness. The ECB recently announced plans for a new unsecured overnight rate whose features will be determined over the coming year.
Deutsche Boerse’s Eurex derivatives exchange - CurveGlobal’s primary competitor for longer-dated interest rate contracts such as Bund futures - also sees alternative rates as an opportunity. The Frankfurt-based exchange currently offers futures on Eonia, but trading remains sparse.
“There is certainly the need to come up with a benchmark on real traded prices and it will help if regulators provide guidance,” said Thomas Book, CEO of Eurex, speaking at the Futures Industry Association’s annual futures and options event in Chicago last week. “We will closely look at it, there is now a view in the UK and not yet a view on the EU, but certainly we’ll come up with products to support it,” he said.
A widespread shift away from Libor could loosen the InterContinental Exchange’s European dominance in listed short-term interest rates. The exchange trades as many as 1m futures daily on three-month sterling Libor and three-month Euribor with open interest of around 4m contracts in each.
ICE CEO, Jeff Sprecher, remains sceptical of a shift to alternative rates, not least because of the exchange group’s vested interest in Libor after taking over administration of the tainted benchmark in 2014.
“While these other efforts are going on to replace, which are going to be difficult, there is also an effort going on to make even better,” Sprecher told delegates at the FIA event. “Today it is much better than it was years ago and would be very hard to manipulate,” He said that overnight rates would not be an appropriate reference for many financial contracts, noting ICE’s recent bond and loan refinancing, which extended the group’s reliance on three-month Libor for another five years.
Exchanges hope that by building liquidity in new futures contracts, forward-pricing curves will eventually develop to address that concern. But Sprecher remains sceptical.
“It has been my experience that when you force people to trade something, when there’s not an underlying economic reason for it, it’s very difficult,” said Sprecher. “If we could do that, we would all be doing that every day.”
For CurveGlobal, the new contracts could be pivotal in driving the future of an exchange that has so far relied on taking market share from competitors in copy-cat contracts.
The London-based bourse currently represents just 2% of open interest in short sterling contracts, rising to 5% of daily traded volume on the most active days. According to Ross, however, the platform accounts for as much as 25% of on-the-touch liquidity, where it offers the same or best price compared to competitors.
“We’ve done pretty well in building a healthy order book but it’s hard work to move open interest from existing providers,” said Ross.
“If there’s a jump ball available by regulatory fiat for a new product, that’s something that we clearly want to innovate around, perhaps more so than others who have a vested interest in the status quo.”
With a strategy that offers margin savings to clients by netting listed futures against over-the-counter swaps cleared at LCH, CurveGlobal’s approach is being matched by a simultaneous effort to expand Sonia swaps clearing at SwapClear. The clearinghouse currently clears contracts out to 30 years and plans to expand the service to 50-year swaps.
The US Federal Reserve aims to start publishing a new Secured Overnight Funding Rate (SOFR) by mid-2018. The new benchmark, a broad Treasury repo rate, was selected in June by the Altentative Reference Rates Committee. (Reporting by Helen Bartholomew)