1 00:00:10,840 --> 00:00:14,320 Speaker 1: Hello, and welcome to another episode of the Odd Lots podcast. 2 00:00:14,400 --> 00:00:18,639 Speaker 1: I'm Tracy Allaway and I'm Joe. Wisn'tal so, Joe. We 3 00:00:18,680 --> 00:00:23,919 Speaker 1: are on part two of our epic library series. Yeah, 4 00:00:23,960 --> 00:00:27,400 Speaker 1: I'm this is I'm very excited about this series. I'm 5 00:00:27,680 --> 00:00:30,720 Speaker 1: you know, I always learn a lot from doing these 6 00:00:30,720 --> 00:00:33,879 Speaker 1: podcasts with you, but this is one area that I 7 00:00:33,960 --> 00:00:38,600 Speaker 1: know is a incredibly important to the way the financial 8 00:00:38,720 --> 00:00:42,720 Speaker 1: system works library and the transition away from it, and 9 00:00:42,760 --> 00:00:45,919 Speaker 1: also an area that I don't know nearly enough. So 10 00:00:46,000 --> 00:00:49,120 Speaker 1: I'm very excited that we are moving on to part 11 00:00:49,159 --> 00:00:53,599 Speaker 1: two of this year. Yeah, and just as a reminder, 12 00:00:54,040 --> 00:00:57,640 Speaker 1: if you haven't listened to the first episode, you definitely should. 13 00:00:58,240 --> 00:01:02,080 Speaker 1: But we basically spoke about everything that went wrong with libror, 14 00:01:02,400 --> 00:01:06,120 Speaker 1: sort of pre and post financial crisis, So just as 15 00:01:06,120 --> 00:01:09,840 Speaker 1: a quick reminder, there was a huge library scandal. The 16 00:01:09,920 --> 00:01:15,080 Speaker 1: idea of having banks submit the reference rate for basically 17 00:01:15,080 --> 00:01:18,720 Speaker 1: an unsecured loan that would be made between dealer banks 18 00:01:19,160 --> 00:01:22,639 Speaker 1: was really thrown into doubt and q OR. Fast forward 19 00:01:22,640 --> 00:01:25,319 Speaker 1: to where we are today and there's a huge effort 20 00:01:25,400 --> 00:01:29,480 Speaker 1: underway to try to replace libraor with a brand new 21 00:01:29,560 --> 00:01:33,160 Speaker 1: reference rate, right and just I mean, I assume everyone 22 00:01:33,200 --> 00:01:35,280 Speaker 1: should have listened to the first episode, but just a 23 00:01:35,280 --> 00:01:39,440 Speaker 1: reminder why we care in part is because so many 24 00:01:39,600 --> 00:01:45,160 Speaker 1: financial contract derivative loans, etcetera. Are priced in some way 25 00:01:45,200 --> 00:01:48,120 Speaker 1: off this singular reference rate. And so when it was 26 00:01:48,160 --> 00:01:51,200 Speaker 1: sort of everyone realized that the old one had flaws 27 00:01:52,160 --> 00:01:54,120 Speaker 1: in terms of how it was constructed, and it was 28 00:01:54,160 --> 00:01:57,960 Speaker 1: open to manipulation and so forth. There is now the 29 00:01:58,040 --> 00:02:01,520 Speaker 1: effort underway to get all all these contracts and debts 30 00:02:01,520 --> 00:02:07,800 Speaker 1: and everything else to price around new singular stand Yeah. 31 00:02:07,960 --> 00:02:11,240 Speaker 1: So in this particular episode, we're going to focus on 32 00:02:11,320 --> 00:02:13,360 Speaker 1: what that new reference rate is, and we have really 33 00:02:13,400 --> 00:02:16,600 Speaker 1: the perfect person to talk about it, someone who's been 34 00:02:16,639 --> 00:02:20,760 Speaker 1: covering the short term dollar funding markets for years now, 35 00:02:20,800 --> 00:02:23,600 Speaker 1: and I've certainly been reading his research for years. It's 36 00:02:23,800 --> 00:02:28,360 Speaker 1: Joe Abote, Barclay's analyst. Joe, thanks so much for coming 37 00:02:28,360 --> 00:02:33,120 Speaker 1: on the show. Thank you. How's the library transition going. 38 00:02:33,240 --> 00:02:35,960 Speaker 1: How would you characterize where we actually are at this 39 00:02:36,040 --> 00:02:42,320 Speaker 1: moment in time. I'd say that we're making progress. Um, 40 00:02:42,360 --> 00:02:46,520 Speaker 1: you know, within the last two years, we obviously decided 41 00:02:46,600 --> 00:02:50,880 Speaker 1: on what kind of benchmark replacement rate to use. I 42 00:02:50,919 --> 00:02:53,920 Speaker 1: think the challenge at this point is to get people 43 00:02:53,960 --> 00:02:59,399 Speaker 1: to actually use it. We're seeing developments of in futures 44 00:02:59,440 --> 00:03:04,519 Speaker 1: market and term rates that reference this. We've seen people 45 00:03:04,760 --> 00:03:10,360 Speaker 1: start to issue off of the rate itself. But you 46 00:03:10,360 --> 00:03:15,720 Speaker 1: know this is still, relatively speaking, early days in the process. 47 00:03:15,960 --> 00:03:19,120 Speaker 1: You know, we need to see volumes in particular and 48 00:03:19,840 --> 00:03:24,600 Speaker 1: a number of different sectors, whether it's issuing front in 49 00:03:24,680 --> 00:03:28,200 Speaker 1: terms of borrowing, whether it's in terms of hedging. We 50 00:03:28,240 --> 00:03:30,720 Speaker 1: need to see that activity pick up at this point. 51 00:03:30,840 --> 00:03:37,000 Speaker 1: So I'd say early days, but hopefully optimistic. So just 52 00:03:37,080 --> 00:03:41,240 Speaker 1: to back up for a second, we know that after 53 00:03:41,600 --> 00:03:45,400 Speaker 1: after we sort of agreed upon that Libel couldn't be sustained, 54 00:03:45,960 --> 00:03:50,600 Speaker 1: what are the regulatory demands and from whom were these 55 00:03:50,640 --> 00:03:55,080 Speaker 1: regulatory demands made on the financial system to find and 56 00:03:55,160 --> 00:04:00,400 Speaker 1: develop a new reference rate? So um, pretty much it 57 00:04:00,440 --> 00:04:04,760 Speaker 1: was a global effort, but largely it came from out 58 00:04:04,800 --> 00:04:10,320 Speaker 1: of the UK where they were regulating the p r 59 00:04:10,400 --> 00:04:15,480 Speaker 1: A was regulating the live AR and you know, obviously 60 00:04:15,520 --> 00:04:17,800 Speaker 1: they had done the work, you know, in terms of 61 00:04:17,839 --> 00:04:23,039 Speaker 1: the identifying the deficiencies in the unsecured rate, and so 62 00:04:23,400 --> 00:04:26,760 Speaker 1: you know they were leading the effort. It was adopted 63 00:04:26,760 --> 00:04:30,039 Speaker 1: by the fellow reserve. I think back in two thousand 64 00:04:30,000 --> 00:04:35,440 Speaker 1: and fourteen and the FED effectively convened a committee called 65 00:04:35,480 --> 00:04:39,520 Speaker 1: the Alternative Reference Rate Committee, which then began work to 66 00:04:39,720 --> 00:04:44,280 Speaker 1: find an alternative reference rate, and then once that reference 67 00:04:44,360 --> 00:04:49,600 Speaker 1: rate was decided, the Alternative Reference Rate Committee would move 68 00:04:49,760 --> 00:04:54,560 Speaker 1: to kind of the adoption phase, right, so speaking to 69 00:04:54,960 --> 00:04:57,480 Speaker 1: end users, if you will, to get them to start 70 00:04:57,560 --> 00:05:00,320 Speaker 1: using the new rate. So it's been a you know, 71 00:05:00,360 --> 00:05:03,279 Speaker 1: to your point, it's been a multi multi year process 72 00:05:04,000 --> 00:05:10,320 Speaker 1: begun with regulators. So the alternative reference rate that they 73 00:05:10,400 --> 00:05:13,080 Speaker 1: eventually settled on, and we spoke a little bit about 74 00:05:13,120 --> 00:05:15,320 Speaker 1: this in the first episode, but it's something called the 75 00:05:15,400 --> 00:05:19,520 Speaker 1: Secured Overnight Financing Rate or s o f R. So 76 00:05:19,680 --> 00:05:23,359 Speaker 1: for how did they settle on that one, and what 77 00:05:23,520 --> 00:05:27,360 Speaker 1: in your view is the key difference between it and 78 00:05:27,839 --> 00:05:34,800 Speaker 1: the predecessor LIBOR. They essentially gave the Alternative Reference Rate 79 00:05:34,800 --> 00:05:38,279 Speaker 1: Committee marching orders and told them, you know, find a 80 00:05:38,320 --> 00:05:43,560 Speaker 1: replacement rate. It must be based on transparent liquid and 81 00:05:43,640 --> 00:05:47,839 Speaker 1: deep market um so that you wouldn't have a submission 82 00:05:47,880 --> 00:05:52,360 Speaker 1: process as is the case with live OR, and there 83 00:05:52,360 --> 00:05:56,800 Speaker 1: were certain rates that you were not allowed to use 84 00:05:57,240 --> 00:06:01,039 Speaker 1: basically policy instruments, right, So you could use the FED 85 00:06:01,120 --> 00:06:06,479 Speaker 1: funds rate for example, and you know, after much deliberation, 86 00:06:07,040 --> 00:06:13,120 Speaker 1: the Alternative Refeinary Committee settled on the SOFA. And the 87 00:06:13,200 --> 00:06:16,840 Speaker 1: key difference is that I think between sofur and libor 88 00:06:17,640 --> 00:06:22,560 Speaker 1: are really threefold. Right. One is that the SOFA rate 89 00:06:22,640 --> 00:06:26,680 Speaker 1: is an overnight interest rate, and of course libor as 90 00:06:26,720 --> 00:06:31,599 Speaker 1: a three month rate with a forward looking component. The 91 00:06:31,680 --> 00:06:35,760 Speaker 1: second is that sofur is a treasury repo rate, so 92 00:06:35,800 --> 00:06:39,800 Speaker 1: again it's a secured funding rate and libor is an 93 00:06:39,839 --> 00:06:44,760 Speaker 1: unsecured bank borrowing rate. And then the third element of this, 94 00:06:44,960 --> 00:06:48,920 Speaker 1: which is tied to that, is the fact that libor 95 00:06:49,000 --> 00:06:56,039 Speaker 1: incorporates bank credit risk, which is not present in sofur. Right, 96 00:06:56,160 --> 00:07:01,240 Speaker 1: So as a treasury repo rate, essentially your boring money 97 00:07:01,360 --> 00:07:06,080 Speaker 1: by pledging treasury collateral, it should be especially on an 98 00:07:06,080 --> 00:07:09,920 Speaker 1: overnight basis, should be risk free. So again you have 99 00:07:10,000 --> 00:07:13,920 Speaker 1: a credit component a term component that are not present 100 00:07:14,120 --> 00:07:19,520 Speaker 1: in the in in in so fur. So you mentioned 101 00:07:19,840 --> 00:07:24,320 Speaker 1: that the the sort of benchmark rate couldn't be just 102 00:07:24,480 --> 00:07:28,560 Speaker 1: a pure policy rate, So we can't just say, oh, 103 00:07:28,640 --> 00:07:32,440 Speaker 1: based on Fed funds, But isn't a system that sort 104 00:07:32,480 --> 00:07:36,880 Speaker 1: of de facto if it's based on the repot prices 105 00:07:36,960 --> 00:07:40,920 Speaker 1: and reposing credit free treasuries, isn't it. It sounds to 106 00:07:41,000 --> 00:07:45,640 Speaker 1: me like kind of a backdoor policy rate. Nonetheless, I 107 00:07:45,680 --> 00:07:50,960 Speaker 1: think that's correct. I think that, you know, so FUR 108 00:07:52,240 --> 00:07:57,360 Speaker 1: moves in tandem with UH with changes in the policy rate. 109 00:07:57,440 --> 00:07:59,840 Speaker 1: So when the FED cuts rates, so FUR goes down, 110 00:08:00,320 --> 00:08:03,040 Speaker 1: and generally speaking, it goes down by about the same amount. 111 00:08:03,920 --> 00:08:08,640 Speaker 1: I think the difference is that the FEDS policy rate, 112 00:08:08,760 --> 00:08:12,200 Speaker 1: the FED funds rate, is based on a fairly small 113 00:08:12,280 --> 00:08:19,920 Speaker 1: market and there's only effectively one lender in that market. 114 00:08:19,960 --> 00:08:23,920 Speaker 1: You know, the FED doesn't want to tie its policy 115 00:08:24,040 --> 00:08:27,760 Speaker 1: to a benchmark interest rate where it's possible in the 116 00:08:27,760 --> 00:08:30,800 Speaker 1: future that, let's say the FED decides that the Fed 117 00:08:30,800 --> 00:08:33,680 Speaker 1: funds market is too small and wants to use a 118 00:08:33,679 --> 00:08:38,360 Speaker 1: different policy instrument. If all of these a hundred trillion 119 00:08:38,400 --> 00:08:40,560 Speaker 1: dollars or so in terms of live or exposure for 120 00:08:40,600 --> 00:08:42,840 Speaker 1: all of that was based on FED funds, you know, 121 00:08:42,920 --> 00:08:45,040 Speaker 1: moving to a different policy rate would be a much 122 00:08:45,080 --> 00:08:49,000 Speaker 1: more complicated issue than just deciding on, you know, the 123 00:08:49,040 --> 00:08:52,719 Speaker 1: communications strategy that the FED is going to adopt. So 124 00:08:53,640 --> 00:08:58,000 Speaker 1: I agree it's kind of a back door approach, but again, 125 00:08:58,160 --> 00:09:02,080 Speaker 1: so far is based st on you know, a huge 126 00:09:02,200 --> 00:09:07,320 Speaker 1: volume of transactions. One final point that I want to 127 00:09:07,360 --> 00:09:10,640 Speaker 1: make too, is that in an ideal world, the FED 128 00:09:10,720 --> 00:09:16,120 Speaker 1: has complete control over the FED funds rate in REPO 129 00:09:16,200 --> 00:09:22,760 Speaker 1: and in sofur. The FED doesn't have complete control over sofur. 130 00:09:23,600 --> 00:09:28,040 Speaker 1: It can influence sofur and is very effective in doing that, 131 00:09:28,160 --> 00:09:33,040 Speaker 1: but you know, sometimes sofur moves um, you know, kind 132 00:09:33,040 --> 00:09:39,560 Speaker 1: of independent of FED actions. I wanted to bring up 133 00:09:39,920 --> 00:09:43,200 Speaker 1: exactly this point, which is, in September of last year, 134 00:09:43,559 --> 00:09:48,199 Speaker 1: we saw REPO the REBO rate shoot up, and then 135 00:09:48,240 --> 00:09:51,960 Speaker 1: we saw the sofur rate basically spike along with it. 136 00:09:52,080 --> 00:09:54,120 Speaker 1: And there were some people at the time who made 137 00:09:54,160 --> 00:09:56,280 Speaker 1: the point that maybe you don't want a reference rate 138 00:09:56,360 --> 00:10:00,480 Speaker 1: that can be that volatile UM. What's your away from 139 00:10:00,520 --> 00:10:04,839 Speaker 1: that experience? My takeaway from the experience is that yes, 140 00:10:05,000 --> 00:10:07,480 Speaker 1: that you know, as I was saying before, you know 141 00:10:08,040 --> 00:10:11,360 Speaker 1: so for if it can influence it but can't control it, 142 00:10:11,640 --> 00:10:14,840 Speaker 1: you know, on a high frequency basis day by day. 143 00:10:15,280 --> 00:10:19,800 Speaker 1: I think the volatility in the overnight sofa rate is 144 00:10:20,520 --> 00:10:23,880 Speaker 1: a little bit misleading, in part because the expectation is 145 00:10:23,920 --> 00:10:30,320 Speaker 1: that when people you know moved to a sofa world, 146 00:10:30,360 --> 00:10:35,040 Speaker 1: they're going to be using an average of daily SOFA quotes. 147 00:10:35,280 --> 00:10:38,400 Speaker 1: So you're gonna be looking at you know, whether it's 148 00:10:38,400 --> 00:10:41,839 Speaker 1: a three month average, one month average, You're going to 149 00:10:41,920 --> 00:10:45,480 Speaker 1: be taking that as as your benchmark reference rate as 150 00:10:45,480 --> 00:10:48,520 Speaker 1: opposed to the overnight interest rate. So that should take 151 00:10:48,640 --> 00:10:51,360 Speaker 1: some of the volatility out of the out of the 152 00:10:51,440 --> 00:10:55,760 Speaker 1: overnight rate that you know people are concerned about. But again, 153 00:10:56,200 --> 00:10:59,520 Speaker 1: you have to take an overnight interest rate and convert 154 00:10:59,600 --> 00:11:03,760 Speaker 1: that to a term rate like library, which means that 155 00:11:03,840 --> 00:11:07,480 Speaker 1: you're doing some averaging. The question is am I doing 156 00:11:07,559 --> 00:11:11,760 Speaker 1: averaging from a backward looking perspective or am I doing 157 00:11:11,800 --> 00:11:15,559 Speaker 1: the averaging from a forward looking perspective? And that's a 158 00:11:15,640 --> 00:11:21,360 Speaker 1: key difference between libor and SOFER right where library is 159 00:11:21,720 --> 00:11:24,040 Speaker 1: you know, kind of what do I think the average 160 00:11:25,520 --> 00:11:27,800 Speaker 1: bank funding rate is going to be over the three months? 161 00:11:28,440 --> 00:11:33,240 Speaker 1: If I'm looking at so FUR, I'm basically saying, you know, 162 00:11:33,559 --> 00:11:38,240 Speaker 1: at least at this point, what's the average overnight interest 163 00:11:38,320 --> 00:11:43,960 Speaker 1: rate over the past three months? Right, And that's a 164 00:11:43,960 --> 00:12:02,920 Speaker 1: little bit different than libor. Mhm h Joe. I have 165 00:12:03,040 --> 00:12:06,240 Speaker 1: a quick question and then a follow up question. The 166 00:12:06,320 --> 00:12:11,800 Speaker 1: quick question is what is the official deadline? Remind me 167 00:12:11,960 --> 00:12:15,160 Speaker 1: for when this transition is supposed to have been complete. 168 00:12:15,960 --> 00:12:19,720 Speaker 1: So the official deadline for the end of publication of 169 00:12:19,880 --> 00:12:26,480 Speaker 1: libra ar is December. Okay, So the longer question I 170 00:12:26,520 --> 00:12:30,280 Speaker 1: have is explained to us the complexity why is it? 171 00:12:30,679 --> 00:12:33,040 Speaker 1: And I you were just talking a little bit about 172 00:12:33,080 --> 00:12:34,920 Speaker 1: it in terms of the depth of this market and 173 00:12:34,960 --> 00:12:38,680 Speaker 1: the challenge of converting an overnight rate into a term rate. 174 00:12:39,280 --> 00:12:42,680 Speaker 1: Talk to us about the specific difficulties of you have 175 00:12:42,760 --> 00:12:46,760 Speaker 1: all these contracts that are denominated in lib or, why 176 00:12:47,000 --> 00:12:50,360 Speaker 1: we can't just go through all the contracts, scratch out 177 00:12:50,360 --> 00:12:53,880 Speaker 1: the line lieb or replaced them with so fur and 178 00:12:54,160 --> 00:12:57,439 Speaker 1: the new world is here. Yeah, I mean, I wish 179 00:12:57,440 --> 00:13:00,320 Speaker 1: it were that simple. Uh turns out and I where 180 00:13:00,320 --> 00:13:02,679 Speaker 1: it's not. Otherwise we wouldn't even be having this conversation. 181 00:13:02,760 --> 00:13:06,320 Speaker 1: But yeah, I mean, I think, first of all, there's 182 00:13:06,320 --> 00:13:11,439 Speaker 1: a technological challenge, right that in many cases there's hundreds 183 00:13:11,440 --> 00:13:18,080 Speaker 1: and thousands of different instruments or references that a single 184 00:13:18,160 --> 00:13:21,760 Speaker 1: bank may have that refers to library. You can take 185 00:13:21,760 --> 00:13:25,880 Speaker 1: the example of of an oil company, for example, where 186 00:13:26,840 --> 00:13:31,240 Speaker 1: it's not really using libor as a boring rate, it's 187 00:13:31,360 --> 00:13:35,480 Speaker 1: using it as a penalty rate for people who you know, 188 00:13:35,640 --> 00:13:38,320 Speaker 1: hypothetically don't make a delivery, they have to pay a 189 00:13:38,400 --> 00:13:42,320 Speaker 1: charge that's equal to libor plus five hundred, and you 190 00:13:42,320 --> 00:13:44,720 Speaker 1: have to go through and find all of those references, 191 00:13:44,760 --> 00:13:49,080 Speaker 1: which is a monumental task. The second element of this, 192 00:13:49,679 --> 00:13:54,280 Speaker 1: I think is that when you look at most financial 193 00:13:54,320 --> 00:13:59,880 Speaker 1: market contracts, they have not been you know, written with 194 00:14:00,080 --> 00:14:04,680 Speaker 1: fallback clauses or adequate fallback clauses for situation in which 195 00:14:04,720 --> 00:14:09,439 Speaker 1: live board doesn't exist. So you know, they were kind 196 00:14:09,440 --> 00:14:17,040 Speaker 1: of developed without a replacement rate in mind. And because 197 00:14:17,080 --> 00:14:22,000 Speaker 1: of that there are certain things that can happen. So 198 00:14:22,480 --> 00:14:27,320 Speaker 1: if you had, you know, some contracts where you know 199 00:14:27,400 --> 00:14:32,520 Speaker 1: the default assumption if libralar is not available, is the 200 00:14:32,560 --> 00:14:37,640 Speaker 1: floating rate on your instrument becomes whatever the last posted 201 00:14:37,720 --> 00:14:42,720 Speaker 1: libel rate was, and your security becomes effectively a fixed 202 00:14:42,800 --> 00:14:47,160 Speaker 1: rate security. So let's say that you've hedged yourself, or 203 00:14:47,240 --> 00:14:51,520 Speaker 1: you think you've hedged yourself against interest rate risk. You're 204 00:14:51,560 --> 00:14:54,160 Speaker 1: now going to have an instrument where you know the 205 00:14:54,240 --> 00:14:58,800 Speaker 1: final years of its maturity, it's fixed, and that interest 206 00:14:58,880 --> 00:15:02,400 Speaker 1: rate is whatever happened to be the last posted libelry rate. 207 00:15:02,480 --> 00:15:06,760 Speaker 1: So if we're in a super high interest rate environment 208 00:15:07,560 --> 00:15:11,640 Speaker 1: at some point and you fixed it at whatever that 209 00:15:11,800 --> 00:15:15,600 Speaker 1: rate is and rates fall, you're going to be experiencing 210 00:15:16,240 --> 00:15:19,600 Speaker 1: payment shock of some kind. So I think that that 211 00:15:19,600 --> 00:15:23,080 Speaker 1: that's the problem. And again it's a big legal challenge 212 00:15:23,160 --> 00:15:26,000 Speaker 1: to kind of go through and write these or rewrite 213 00:15:26,000 --> 00:15:30,760 Speaker 1: these fallbacks. And that's just that's floating rate notes. I'm 214 00:15:30,760 --> 00:15:36,120 Speaker 1: not talking about mortgages or syndicated loans and things like that, 215 00:15:36,240 --> 00:15:39,240 Speaker 1: where you know, in some cases you need to have 216 00:15:39,320 --> 00:15:42,960 Speaker 1: a approval of all the investors to agree to change 217 00:15:42,960 --> 00:15:45,760 Speaker 1: the coupon on a security. It's a much much bigger 218 00:15:45,840 --> 00:15:49,440 Speaker 1: challenge than just cutting and pasting. Are there any operational 219 00:15:49,680 --> 00:15:54,240 Speaker 1: risks in the meantime during this time when we're actually 220 00:15:54,280 --> 00:15:59,000 Speaker 1: making the transition from libor to sofer? For instance, a 221 00:15:59,040 --> 00:16:01,400 Speaker 1: few people have been to talking about the prospect of 222 00:16:01,920 --> 00:16:06,600 Speaker 1: zombie libor, which is this reference rate that is sort 223 00:16:06,600 --> 00:16:10,720 Speaker 1: of dead but basically still operational and haunting the market 224 00:16:10,760 --> 00:16:14,040 Speaker 1: in many ways and might not be totally reflective of 225 00:16:14,280 --> 00:16:17,640 Speaker 1: what's actually going on in funding markets. Is that a risk? 226 00:16:18,280 --> 00:16:21,440 Speaker 1: I think it's a potential risk, although I think that 227 00:16:22,440 --> 00:16:27,200 Speaker 1: regulators are you know, realizing that that's a challenge, and 228 00:16:27,320 --> 00:16:32,400 Speaker 1: so you know, the they've been kind of recommending people 229 00:16:32,480 --> 00:16:35,880 Speaker 1: put in kind of what's known as pre cessation clauses, 230 00:16:36,920 --> 00:16:41,760 Speaker 1: and the pre cessation clause would basically, you know, kind 231 00:16:41,760 --> 00:16:45,200 Speaker 1: of trigger itself in the event that regulators deem that 232 00:16:45,360 --> 00:16:51,240 Speaker 1: libor itself is not a representative interest rate. Once that happens, 233 00:16:51,520 --> 00:16:55,200 Speaker 1: you know, the expectation is that publication of library would cease. 234 00:16:56,000 --> 00:16:59,880 Speaker 1: To your point about the zombie situation, you might have 235 00:17:00,200 --> 00:17:04,000 Speaker 1: a scenario, let's say, where you know, regulators have said 236 00:17:04,000 --> 00:17:10,359 Speaker 1: the rate is no longer representative, but it's still being published. 237 00:17:10,640 --> 00:17:13,160 Speaker 1: So you now have kind of a published interest rate 238 00:17:13,240 --> 00:17:18,320 Speaker 1: that people can you know, legally still use, but it's 239 00:17:18,359 --> 00:17:21,520 Speaker 1: been deemed unrepresentative. And that that's kind of your zombie 240 00:17:21,560 --> 00:17:27,960 Speaker 1: lib or situation. You know. Zombie libor in other cases 241 00:17:27,960 --> 00:17:31,639 Speaker 1: would require banks to kind of continue to contribute to 242 00:17:31,760 --> 00:17:37,199 Speaker 1: the libor panel. And I struggled to see situations in 243 00:17:37,200 --> 00:17:42,920 Speaker 1: which banks would willingly contribute to uh AN index when 244 00:17:43,400 --> 00:17:47,080 Speaker 1: they don't have to and when there's an alternative benchmark 245 00:17:47,200 --> 00:17:50,440 Speaker 1: that other people are using. So to me, I think 246 00:17:50,480 --> 00:17:56,760 Speaker 1: that zombie library risk is is a low probability, but 247 00:17:57,000 --> 00:17:59,879 Speaker 1: you know there's probably other operational risk that we need 248 00:18:00,119 --> 00:18:03,080 Speaker 1: consider that. You know, people are working on right now, 249 00:18:04,640 --> 00:18:10,600 Speaker 1: so just in terms of hitting regulatory benchmarks in demands, 250 00:18:10,600 --> 00:18:13,960 Speaker 1: how realistic are they in your view in terms of 251 00:18:14,000 --> 00:18:18,560 Speaker 1: making this changeover and what other kind of forbearance or 252 00:18:18,880 --> 00:18:22,000 Speaker 1: moves might regulators be forced to make, you know, in 253 00:18:22,119 --> 00:18:25,119 Speaker 1: the coming months ahead to deal with the question of 254 00:18:25,119 --> 00:18:29,600 Speaker 1: whether we can actually UH Sunset Library as planned. You know, 255 00:18:29,640 --> 00:18:31,919 Speaker 1: you could probably make the case that there should be 256 00:18:32,000 --> 00:18:39,040 Speaker 1: a legislative approach that prevents you know, a litany of 257 00:18:39,520 --> 00:18:45,240 Speaker 1: UM lawsuits that could follow, you know, triggering of fallbacks 258 00:18:45,280 --> 00:18:49,240 Speaker 1: and the replacement of the of LIB or we might 259 00:18:49,320 --> 00:18:52,560 Speaker 1: see something along those lines UM in the future right 260 00:18:52,600 --> 00:18:55,800 Speaker 1: to kind of speed the process along and to kind 261 00:18:55,800 --> 00:18:59,800 Speaker 1: of prevent it from getting gummed up. Banks are probably 262 00:19:00,960 --> 00:19:04,399 Speaker 1: the furthest along in terms of the transition and making 263 00:19:04,440 --> 00:19:08,919 Speaker 1: the necessary language and fullbacks and things like that. I 264 00:19:08,960 --> 00:19:13,760 Speaker 1: think the non financial sector is probably not quite as 265 00:19:14,520 --> 00:19:17,920 Speaker 1: far along in this process, and you know that might 266 00:19:18,040 --> 00:19:25,800 Speaker 1: require you know, more education and urgency from ARC and regulators. 267 00:19:26,280 --> 00:19:28,560 Speaker 1: I'm not sure how that gets done, to be honest. 268 00:19:29,600 --> 00:19:34,120 Speaker 1: How much does UM the creation of things like um 269 00:19:34,359 --> 00:19:38,200 Speaker 1: SO for futures actually help, because I think the Creme 270 00:19:38,400 --> 00:19:41,639 Speaker 1: has been rolling out those contracts UM and we've actually 271 00:19:41,680 --> 00:19:46,080 Speaker 1: had a few trades. Does that help with adoption? I 272 00:19:46,119 --> 00:19:50,000 Speaker 1: actually think it's necessary for adoption. Right. You need to 273 00:19:50,040 --> 00:19:53,760 Speaker 1: drive it as market that you can rely on for 274 00:19:54,040 --> 00:19:58,439 Speaker 1: two reasons. One is to develop that term forward looking 275 00:19:59,200 --> 00:20:02,879 Speaker 1: so for rate that I mentioned earlier. The second is 276 00:20:02,960 --> 00:20:06,120 Speaker 1: that you need this market to be able to hedge. Right, 277 00:20:06,200 --> 00:20:08,880 Speaker 1: you need to be able to know that I can 278 00:20:08,920 --> 00:20:13,040 Speaker 1: convert a series of floating rate payments into fixed rate payments. 279 00:20:13,080 --> 00:20:15,879 Speaker 1: If I want to go in the other direction, you 280 00:20:15,920 --> 00:20:18,640 Speaker 1: need to be able to kind of to your point earlier, 281 00:20:18,680 --> 00:20:22,639 Speaker 1: I want to hedge against changes in FED policy, for example, 282 00:20:23,240 --> 00:20:24,760 Speaker 1: so I want to be able to use an interest 283 00:20:24,840 --> 00:20:27,600 Speaker 1: rate that allows me to do that. So the ruts 284 00:20:27,680 --> 00:20:34,160 Speaker 1: market is absolutely crucial for adoption of SOFA. Just remember 285 00:20:34,240 --> 00:20:38,679 Speaker 1: that the your dollar market is massive compared to the 286 00:20:38,760 --> 00:20:44,440 Speaker 1: size of the actual underlying trades that go into lib or. 287 00:20:45,119 --> 00:20:48,800 Speaker 1: So if you think about just the size of your 288 00:20:48,840 --> 00:20:51,520 Speaker 1: dollar futures, and I think it's something like two or 289 00:20:51,520 --> 00:20:55,800 Speaker 1: three million UH contracts that get traded on a daily basis, 290 00:20:57,000 --> 00:21:00,960 Speaker 1: you compare that to what really am ouns to about 291 00:21:01,040 --> 00:21:03,480 Speaker 1: a hundred and fifty million dollars a day in double 292 00:21:03,520 --> 00:21:07,959 Speaker 1: a financial cp issuance. You get to see how the 293 00:21:08,000 --> 00:21:12,280 Speaker 1: derivatives market is actually far more significant, at least in 294 00:21:12,359 --> 00:21:15,399 Speaker 1: terms of size, than the actual cash market. In the 295 00:21:15,480 --> 00:21:19,520 Speaker 1: case of Sofur, it's the opposite. We have a much 296 00:21:19,600 --> 00:21:24,200 Speaker 1: bigger cash market, right, so for volumes about a trillion 297 00:21:24,240 --> 00:21:28,159 Speaker 1: dollars and you know, something like I don't know, and 298 00:21:28,200 --> 00:21:30,160 Speaker 1: I'm gonna probably gonna get this wrong, but a few 299 00:21:30,240 --> 00:21:33,800 Speaker 1: hundred thousand contracts are trading on a daily basis, and 300 00:21:33,800 --> 00:21:36,639 Speaker 1: so for future so again, you know, I think the 301 00:21:36,720 --> 00:21:39,600 Speaker 1: perspective here is the same, which is that the cash 302 00:21:39,680 --> 00:21:44,080 Speaker 1: market a lot of volume futures market needs to develop 303 00:21:44,920 --> 00:21:47,679 Speaker 1: in order for the for broader adoption is so fur. 304 00:22:05,440 --> 00:22:09,119 Speaker 1: So just talking about the transition and potential problems is 305 00:22:09,640 --> 00:22:14,159 Speaker 1: halfhearted transition a place where we could see some difficulties. So, 306 00:22:14,240 --> 00:22:17,680 Speaker 1: for instance, if a company is borrowing at a libor 307 00:22:17,800 --> 00:22:23,040 Speaker 1: based rate but they're getting money from a SOFER based swap, 308 00:22:23,640 --> 00:22:26,520 Speaker 1: that could end up being like quite a bad mismatch. 309 00:22:26,640 --> 00:22:30,840 Speaker 1: I would imagine, does that come up at all? That 310 00:22:31,000 --> 00:22:37,320 Speaker 1: comes up frequently. So the issue is particularly acute for 311 00:22:38,080 --> 00:22:42,359 Speaker 1: certain types of banks, who's you know, lending activity is 312 00:22:42,400 --> 00:22:45,399 Speaker 1: all based off kind of libor and their funding is 313 00:22:46,000 --> 00:22:48,160 Speaker 1: also off of lib or if they have to start 314 00:22:48,200 --> 00:22:51,280 Speaker 1: making loans off and so for, but their funding is 315 00:22:51,400 --> 00:22:56,439 Speaker 1: kind of all off of library. There's a mismatch, you know. 316 00:22:56,600 --> 00:23:01,000 Speaker 1: The the big concern that people have is that, you know, 317 00:23:01,040 --> 00:23:05,800 Speaker 1: you've got a lending rate that implicitly includes a bank 318 00:23:05,840 --> 00:23:11,439 Speaker 1: credit component, and you know, a borrowing rate let's say 319 00:23:11,480 --> 00:23:14,960 Speaker 1: that's based off of a risk free rate. What happens 320 00:23:15,000 --> 00:23:19,040 Speaker 1: in an environment, let's say where there's a flight to 321 00:23:19,160 --> 00:23:25,080 Speaker 1: quality and people are piling into treasuries and repo and 322 00:23:25,160 --> 00:23:28,720 Speaker 1: those rates are falling, but you're borrowing is all based 323 00:23:28,760 --> 00:23:31,680 Speaker 1: off of lie or, and that's moving in the other 324 00:23:31,720 --> 00:23:35,720 Speaker 1: direction because bank credit risk is going up and there's 325 00:23:35,720 --> 00:23:39,600 Speaker 1: no easy solution to that. To be honest, you can 326 00:23:39,720 --> 00:23:42,560 Speaker 1: again rely on the derivatives market to kind of hedge 327 00:23:42,600 --> 00:23:46,280 Speaker 1: some of that. But you know, the concern that people 328 00:23:46,320 --> 00:23:50,199 Speaker 1: have is that there's a mismatch there. And you know 329 00:23:50,240 --> 00:23:52,520 Speaker 1: the answer to this is that there will be a 330 00:23:52,600 --> 00:23:57,960 Speaker 1: market that develops and picks up volume to kind of 331 00:23:57,960 --> 00:24:01,160 Speaker 1: offset that rally risk if you want to call it. That. 332 00:24:01,440 --> 00:24:04,280 Speaker 1: There will be a cost associated with it. My dealers 333 00:24:04,280 --> 00:24:06,639 Speaker 1: are going to charge people for that. But again, it 334 00:24:07,000 --> 00:24:12,200 Speaker 1: does add to the cost of transitioning to sofer. Last question, Joe, 335 00:24:12,240 --> 00:24:14,760 Speaker 1: because I know you have to go, but as all 336 00:24:14,800 --> 00:24:19,440 Speaker 1: these issues crop up, doesn't make you maybe more sympathetic 337 00:24:19,600 --> 00:24:22,840 Speaker 1: to the library process as it was like, maybe there's 338 00:24:22,880 --> 00:24:28,040 Speaker 1: a benefit to having banks come up with interest rates. Uh, 339 00:24:28,080 --> 00:24:30,720 Speaker 1: you know, clearly it's embedded in the financial system as well. 340 00:24:30,760 --> 00:24:33,600 Speaker 1: But maybe maybe you can make an argument even that 341 00:24:33,800 --> 00:24:37,520 Speaker 1: it's countercyclical. I'm being a little bit facetious by the 342 00:24:37,520 --> 00:24:42,160 Speaker 1: way I suppose you could, But to be honest, I'd 343 00:24:42,240 --> 00:24:45,440 Speaker 1: much rather have an interest rate that's based on transactions 344 00:24:45,960 --> 00:24:50,960 Speaker 1: UM and transparent transactions that I can look at. I 345 00:24:51,119 --> 00:24:55,280 Speaker 1: struggle because you know, I can look at REPO and 346 00:24:55,560 --> 00:24:58,840 Speaker 1: I think I have a decent understanding of what, you know, 347 00:24:58,880 --> 00:25:02,240 Speaker 1: are the factors that move and drive repo. I have 348 00:25:02,760 --> 00:25:08,880 Speaker 1: little or no transparency into bank boring rates beyond what 349 00:25:08,960 --> 00:25:11,960 Speaker 1: I can see in you know, the commercial paper market, 350 00:25:13,040 --> 00:25:17,919 Speaker 1: and oftentimes I'm I see movements in library of you know, 351 00:25:18,640 --> 00:25:22,480 Speaker 1: in some cases a couple of basis points, and I 352 00:25:22,520 --> 00:25:26,119 Speaker 1: have no explanation for that move That to me, makes 353 00:25:26,160 --> 00:25:31,440 Speaker 1: it a difficult benchmark interest rate to use. If you 354 00:25:31,440 --> 00:25:33,879 Speaker 1: you know, if you can't understand why it's moving on 355 00:25:33,920 --> 00:25:37,200 Speaker 1: a day by day basis so far. On the other hand, 356 00:25:37,240 --> 00:25:40,359 Speaker 1: I can kind of get I kind of understand why 357 00:25:40,400 --> 00:25:42,840 Speaker 1: it moves up and down. I may not be able 358 00:25:42,880 --> 00:25:46,480 Speaker 1: to forecast it on a daily basis with precision, but 359 00:25:46,560 --> 00:25:49,320 Speaker 1: at least kind of understand what's going on in that market. 360 00:25:50,240 --> 00:25:53,800 Speaker 1: There's a lot less transparency and um, you know, in 361 00:25:53,960 --> 00:25:58,680 Speaker 1: the markets that are underlying Library, and I don't want 362 00:25:58,680 --> 00:26:01,720 Speaker 1: to get into the all of the details, but Library 363 00:26:01,760 --> 00:26:06,040 Speaker 1: is increasingly relying on Level three submissions, which basically require 364 00:26:06,119 --> 00:26:10,600 Speaker 1: inputs from various different markets and different waitings attached to them. 365 00:26:10,640 --> 00:26:14,280 Speaker 1: So you're getting even less transparency in the submission process 366 00:26:14,720 --> 00:26:19,119 Speaker 1: as the library moves further and further closer and closer 367 00:26:19,160 --> 00:26:22,840 Speaker 1: to its um it's deadline. Well, Joe, I think that's 368 00:26:22,840 --> 00:26:25,040 Speaker 1: a good place to leave it. Thank you so much 369 00:26:25,119 --> 00:26:28,840 Speaker 1: for coming on the show. We really appreciate it. Thank you. 370 00:26:29,640 --> 00:26:39,840 Speaker 1: Thanks sure, that was great. I learned a lot. I 371 00:26:39,920 --> 00:26:42,720 Speaker 1: enjoyed that conversation. I know we got a little bit 372 00:26:42,840 --> 00:26:46,040 Speaker 1: um detailed in some parts of it, but I think 373 00:26:46,080 --> 00:26:48,240 Speaker 1: that's the way to go, given that so much of 374 00:26:48,280 --> 00:26:54,280 Speaker 1: the transition away from Library is actually all about those technicalities, 375 00:26:54,680 --> 00:27:00,280 Speaker 1: like how do you the contracts which never foresaw this 376 00:27:00,320 --> 00:27:02,520 Speaker 1: notion that one day we would be moving away from 377 00:27:02,560 --> 00:27:06,200 Speaker 1: live horror? Yeah, exactly right. I mean I do think 378 00:27:06,320 --> 00:27:09,880 Speaker 1: like in my mind this idea that's like, okay, well, 379 00:27:10,040 --> 00:27:14,320 Speaker 1: libra or roughly trades in line with every other interest 380 00:27:14,400 --> 00:27:17,639 Speaker 1: rate most of the time, and so for more or 381 00:27:17,720 --> 00:27:21,520 Speaker 1: less trading in line with policy rates except for some 382 00:27:21,680 --> 00:27:25,760 Speaker 1: occasional deviation. So why can't you just swap them? And 383 00:27:25,840 --> 00:27:29,800 Speaker 1: I thought Joe did a great uh job explaining why 384 00:27:30,000 --> 00:27:34,119 Speaker 1: nothing is remotely that simple when you're talking about rewriting 385 00:27:34,160 --> 00:27:39,679 Speaker 1: contracts that never had this kind of one step shift 386 00:27:39,760 --> 00:27:43,960 Speaker 1: in mind. Right. And the other thing that this really 387 00:27:43,960 --> 00:27:47,119 Speaker 1: puts me in mind of is that zombie librar ideas. 388 00:27:47,119 --> 00:27:50,560 Speaker 1: So not only do you have a shrinking pool of 389 00:27:50,640 --> 00:27:56,000 Speaker 1: banks that are actually submitting their library estimates, as Joe mentioned, 390 00:27:56,400 --> 00:28:00,480 Speaker 1: but you also have those estimates getting priced off level 391 00:28:00,680 --> 00:28:04,200 Speaker 1: three assets, which I don't know people remember, but those 392 00:28:04,200 --> 00:28:07,359 Speaker 1: are the things that are the most difficult to sort 393 00:28:07,400 --> 00:28:10,520 Speaker 1: of price. So there's this notion that library is getting 394 00:28:10,600 --> 00:28:14,879 Speaker 1: sort of sketchier and sketchier while the entire world is 395 00:28:14,920 --> 00:28:17,680 Speaker 1: still trying to get to a place where so far, 396 00:28:17,960 --> 00:28:20,600 Speaker 1: so far is the default. Right? You know what, this, 397 00:28:20,920 --> 00:28:23,879 Speaker 1: this whole transition debate really reminds me of tracing. Are 398 00:28:23,920 --> 00:28:28,400 Speaker 1: you gonna see a bitcoin? I'm really worried? No, no, no, no, no, no, nothing, 399 00:28:28,560 --> 00:28:31,040 Speaker 1: nothing like, okay, go on, what does it remind you? Um? 400 00:28:31,200 --> 00:28:33,480 Speaker 1: You know how? Like ever, once in a while, like 401 00:28:33,600 --> 00:28:36,679 Speaker 1: people will we talk about some social network and like, oh, 402 00:28:36,840 --> 00:28:42,200 Speaker 1: Facebook sucks. Facebook takes our privacy and our Facebook whatever. 403 00:28:42,240 --> 00:28:44,840 Speaker 1: Why can't we all just switch to something new? Or 404 00:28:44,920 --> 00:28:47,560 Speaker 1: Twitter sucks? Why can't we switch to say new? And 405 00:28:47,600 --> 00:28:51,560 Speaker 1: it never seems to happen. And the reason is like 406 00:28:51,680 --> 00:28:55,720 Speaker 1: network effects of a thing that everyone coalesced around are 407 00:28:55,760 --> 00:28:58,160 Speaker 1: not There's no easy way to just sort of like 408 00:28:58,280 --> 00:29:00,720 Speaker 1: red folks like I'll just jump at it, because even 409 00:29:00,720 --> 00:29:04,800 Speaker 1: if if half the people jump, then then each of 410 00:29:04,840 --> 00:29:07,480 Speaker 1: the new networks is not have as valuable, They're much 411 00:29:07,560 --> 00:29:11,480 Speaker 1: less valuable because, for obvious reason, network effects compound. That 412 00:29:11,720 --> 00:29:13,880 Speaker 1: makes sense when people are all on the same thing. 413 00:29:14,520 --> 00:29:16,560 Speaker 1: So many things that we like talk about in the 414 00:29:16,640 --> 00:29:19,000 Speaker 1: real world were like this sucks. Why can't we move 415 00:29:19,040 --> 00:29:23,440 Speaker 1: off it? Whether it's Facebook, whether it's Twitter, whether it's 416 00:29:23,480 --> 00:29:26,160 Speaker 1: the struggles that we've seen of the entire world being 417 00:29:26,200 --> 00:29:29,000 Speaker 1: dependent on the US dollar or for trade. And of 418 00:29:29,040 --> 00:29:32,560 Speaker 1: course this essentially all come down with this problem of 419 00:29:33,000 --> 00:29:35,080 Speaker 1: it's just not so easy for us all to jump 420 00:29:35,120 --> 00:29:37,800 Speaker 1: at the same time onto the new thing, even if 421 00:29:37,800 --> 00:29:41,560 Speaker 1: we could clearly identify the new thing is better. See now, 422 00:29:41,600 --> 00:29:43,520 Speaker 1: I thought you were going to start talking about bitcoin 423 00:29:43,600 --> 00:29:46,880 Speaker 1: because of course network effects where at played there when 424 00:29:46,880 --> 00:29:50,560 Speaker 1: it came to cryptocurrency adoption. Well, I guess that there's 425 00:29:50,680 --> 00:29:53,160 Speaker 1: that too, but you know, no need, no need to 426 00:29:53,160 --> 00:29:56,000 Speaker 1: bring bitcoin. Okay, Yes, I feel kind of bad. All right, 427 00:29:56,120 --> 00:29:58,840 Speaker 1: let's leave it there before um I say anything else. 428 00:29:59,160 --> 00:30:02,080 Speaker 1: This has been an other episode of the All Thoughts podcast. 429 00:30:02,200 --> 00:30:04,720 Speaker 1: I'm Tracy Alloway. You can follow me on Twitter at 430 00:30:04,720 --> 00:30:07,720 Speaker 1: Tracy Alloway and I'm Joe wi Isn't all. You could 431 00:30:07,800 --> 00:30:10,960 Speaker 1: follow me on Twitter at the Stalwart, and you should 432 00:30:11,000 --> 00:30:15,640 Speaker 1: follow our producer on Twitter, Laura Carlson. She's at Laura M. Carlson. 433 00:30:16,120 --> 00:30:20,760 Speaker 1: Follow the Bloomberg head of podcast, Francesca Levi at francesco Today, 434 00:30:21,240 --> 00:30:24,479 Speaker 1: and check out all of the Bloomberg Podcast on Twitter 435 00:30:25,040 --> 00:30:28,120 Speaker 1: under the handle at podcasts. Thanks for listening.