How IBOR Transition Will Impact the Investment Bank Technology Systems Stack
As part of IBOR transition, organizations must collaborate with both vendor trading and market data–systems providers to meet the challenges of adopting alternative reference rates (ARRs).
In this context, there are six major tasks IT systems need to be able to carry out in support of the transition process:
Capture New ARR Rates and Build New Curves
Unwind and Renegotiate Existing Deals
Support New Instruments, Trades and Calculations Based on ARRs
Adapt Risk Frameworks to Support ARRs
Proxy-in Historical Values for New Rates
Provide Documentation for New Trades
1. Capture New ARR Rates and Build New Curves
Market-data providers, including Bloomberg, Reuters and MarkIT are actively tracking the market updates and associated data changes that will underpin IBOR transition. Although activity will vary between vendors, we anticipate that this new functionality will include the following components:
Landing pages for functions pricing and analytics, data and tickers for new rates, with past rates and indices plus their comparison with new ones
Basis-adjusted swap curves with tickers on various adjusted bases
Derivative-pricing engines updated to support ARR curves
New ARR products supported, including IRS, Futures and FRNs
IRS electronic trading portals updated to include bank quotes on ARR – OIS, plus integration with trading and booking platforms, potentially including pre-trade price, post-trade booking and trade-order management systems
Derivative trade–reporting interfaces enhanced to display ARR trade reports
Ingesting and integrating platform data into internal systems is a key requirement. The level of change needed depends on the interface between the market-data provider and the bank’s primary trading system.
It is important to have new rates and indices set up in staging and UAT environments for protracted time periods to facilitate full testing and evaluation cycles.
Within key vendor platforms such as Murex and Calypso, new rates, indices and curves are already available to customers and you can set them up via normal configuration procedures.
2. Unwind and Renegotiate Existing Deals:
Tools and applications are available on vendor platforms to identify and analyze legacy trades. These trade populations can be also amended to reflect IBOR transition scenarios and their potential impact on P&L.
Vendors have built sets of reports detailing the transition impact on each index (e.g., USD LIBOR to SOFR), which can be used to support the renegotiation of legacy contracts. These reporting packs will need to be run many times during the transition period.
Several third-party vendors (e.g., TriOptima, Quantile and Capitalab) also offer tools for portfolio compression. Generally, this is used to reduce the number of trades in a portfolio (minimizing complexity and management costs) while retaining the same risk profile. Applying these tools as part of an IBOR transition program will reduce the number of trades that need to be rebooked as part of the migration process.
3. Support New Instruments, Trades and Calculations Based on ARRs
The ISDA consultation process has indicated that fixing in arrears on compounding daily rate is the preferred approach to rate setting, and that futures estimation is the preferred pricing approach. These approaches require some adjustment to systems but, by and large, they can be supported without the need for significant functional changes.
The preferred IBOR transition mechanisms need good underlying market liquidity, so no one will be able to book new trades (beyond short-term tenors) until suitable liquidity is formed, regardless of how ready the systems are. Technology and market-facing business teams will have to collaborate closely to optimize the timing of IBOR transition across products and asset classes.
As many transition details are yet to be finalized, vendors must offer continuing support for the development, pricing and clearing of new IBOR-based instruments. Assessing the modeling and pricing impacts of new-basis risks, and efficiently packaging the emerging changes is particularly important.
The process of unwinding deals and replacing them with new detailed dashboards to show and control each event (or set of events) for risk and P&L, might require new versions of vendor software.
4. Adapt Risk Frameworks to Support ARRs:
Most ARRs are based on risk-free rates and will move independently of any sector or individual counterparty-specific risk. This means that credit risk will be embedded solely in rate spreads for ARR-based trades. The way curves based on ARRs react to market movements will differ accordingly. While IBOR rates respond to changes in bank-specific risk, ARRs will not respond.
Credit- and market-risk systems will require intensive testing to ensure their responses and reactions to market shocks are accurate and predictable. A detailed review and validation of risk engines between front-office, quantitative and technology teams is also needed.
5. Proxy-in Historical Values for New Rates:
Data for new ARRs will be limited in quantity and quality going back in time. To facilitate market-risk analysis, reliable proxies for past periods will need to be sourced. Also, the spread to matching existing IBOR rates will not be constant over tenor or historical data ranges. In addition, the time required for the risk and technology teams to establish these proxies must not be underestimated or there will be a negative impact on the quality of historical risk–scenario analysis and back testing.
6. Provide Documentation for New Trades:
Fully archiving all existing trade documentation, and ensuring that all new trade information meets ISDA standards and is legally signed-off as well as fully documented and captured, is essential. Storage and management of the information needs to be achieved outside core trading platforms. The operational aspects of IBOR transition should be a project in itself.
Order of Changes
The order in which IBOR transition changes are made to systems is critical. New rates, curves and instruments depend on the specifications for ARRs and products being finalized, and need to be set up first.
Then new instruments and sample trades, until longer tenors are available for ARRs. However, these instruments may not have enough liquidity or sufficiently accurate pricing to justify basing trades upon them. Next, contract and trade documentation changes can proceed in parallel with the proxying of historical data for new rates, and the validation of risk frameworks.
Finally, a migration framework for old trades can be determined. We anticipate that the resulting multilateral negotiation will take time and must be started as soon as ARR regimes are locked down.
Having a comprehensive view of the changing IBOR transition systems will help institutions simplify this complex and multidimensional marketplace challenge.
Aaron Cleavin is a senior capital markets solution delivery professional with more than 20 years’ financial services experience. Mr. Cleavin is extremely well-versed in the delivery of greenfield and existing businesses. He has a detailed understanding of a wide range of financial services businesses, including capital markets, investment banking, funds management and proprietary trading, across a variety of vendor platforms (e.g., Murex, Kondor and Dimension) plus bespoke and proprietary solutions. Aaron has earned an enviable reputation for successfully managing initiatives based on front-, mid- and back-office requirements; initiatives driven by regulatory, revenue growth, cost reduction, capacity and scalability, as well as organizational redesign considerations.