WEBVTT - This Is What Happened To LIBOR During The COVID Crisis 0:00:10.880 --> 0:00:14.240 Hello, and welcome to another episode of the All Thoughts Podcast. 0:00:14.320 --> 0:00:18.560 I'm Tracy Allaway and I'm Joe. So Joe. I know, 0:00:18.640 --> 0:00:21.840 I said our Library series was at an end, but 0:00:22.280 --> 0:00:25.279 as we discussed in the previous episode, I lied, and 0:00:25.320 --> 0:00:28.000 I sort of lied twice because we have two extra 0:00:28.080 --> 0:00:31.520 episodes and this is the second one. Although I promise 0:00:31.640 --> 0:00:34.839 this is actually the last one. Who knows, maybe this 0:00:34.880 --> 0:00:38.159 won't be the last one. What can I say? Library 0:00:38.200 --> 0:00:41.440 gets people fired up and everyone really wants to talk 0:00:41.440 --> 0:00:44.400 about it. But I will say some of the episodes, 0:00:44.600 --> 0:00:48.480 um that were early in our series, we actually recorded 0:00:48.520 --> 0:00:53.000 those before we had the big March sell off in 0:00:53.040 --> 0:00:56.000 all the volatility that we saw in the market. So 0:00:56.400 --> 0:01:00.120 I think we should actually have another discussion about what 0:01:00.160 --> 0:01:02.880 we've seen this year with the coronavirus crisis and what 0:01:03.000 --> 0:01:07.520 it might mean for the library transition. Yeah, no, I agree. 0:01:07.880 --> 0:01:10.120 I do think like it's it's good to talk big 0:01:10.160 --> 0:01:14.360 picture and the sort of long term trajectory of what's 0:01:14.360 --> 0:01:18.120 coming for Library and the replacement. But in the meantime, 0:01:18.200 --> 0:01:23.240 Library still exist, and so talking about how this benchmark, uh, 0:01:23.400 --> 0:01:26.520 you know, what's happened with it during the extraordinary several 0:01:26.520 --> 0:01:29.160 weeks and months for the market is a sort of 0:01:29.200 --> 0:01:32.160 a useful thing as well. I hope, yeah. And I 0:01:32.200 --> 0:01:35.840 guess the big tension that sort of emerges is should 0:01:35.840 --> 0:01:39.520 we be attempting to do this big redesign of the 0:01:39.560 --> 0:01:43.560 financial system, basically redesigning the reference rate to which trillions 0:01:43.560 --> 0:01:46.880 of dollars of assets are tied at a time when 0:01:46.880 --> 0:01:50.960 we're distracted by so much else going on in finance. 0:01:51.040 --> 0:01:53.160 Right We're in the middle of a financial or maybe 0:01:53.200 --> 0:01:56.560 not financial but an economic crisis. The Federal Reserve is 0:01:56.640 --> 0:01:59.880 rolling out all these new programs. Regulators are you know, 0:02:00.040 --> 0:02:03.000 looking at financial stability things like that. Should we be 0:02:03.080 --> 0:02:06.280 tackling library at this exact moment? So we're going to 0:02:06.480 --> 0:02:10.280 explore that tension in this discussion. And we have a 0:02:10.320 --> 0:02:13.520 guest today who is a fan favorite for sure. People 0:02:13.880 --> 0:02:17.160 we've had him on before and he had been requested 0:02:17.200 --> 0:02:19.799 a lot, and then even again I've got requests like, oh, 0:02:19.840 --> 0:02:23.000 you should talk to him again. So everything is aligning 0:02:23.040 --> 0:02:26.880 for this episode are the culmination of the series. The 0:02:27.360 --> 0:02:30.120 interest rate stars have aligned for us, all right, Well, 0:02:30.240 --> 0:02:34.440 without further ado, let's bring on Josh Younger ahead of us. 0:02:34.520 --> 0:02:38.440 Interest rate derivative strategy over at JP Morgan And as 0:02:38.440 --> 0:02:41.200 you mentioned, Joe, a previous odd lots of guests who 0:02:41.240 --> 0:02:43.320 talked a lot about some of the turmoil that we 0:02:43.360 --> 0:02:47.240 saw in the treasury market in March. Josh, it's great 0:02:47.280 --> 0:02:50.160 to have you back on Yeah, it's great to be back. 0:02:50.200 --> 0:02:53.600 Thanks for having me. So maybe just to begin with, 0:02:53.639 --> 0:02:56.160 you could give us a sort of summary of what 0:02:56.360 --> 0:03:00.840 happened to libor in March when we had the market volatility, 0:03:00.840 --> 0:03:03.600 and not just market volatility, but we did start to 0:03:03.639 --> 0:03:08.160 see the beginnings of some concerns about the banking system 0:03:08.240 --> 0:03:11.480 and that sort of reflected in the interbank lending rates. 0:03:11.480 --> 0:03:14.679 So what did we see So, so I think it's 0:03:14.760 --> 0:03:17.080 it's best to go back to two thousand eight, and 0:03:17.080 --> 0:03:20.600 and that was an environment where live Or was this 0:03:20.800 --> 0:03:24.080 really important kind of canary in the coal mine for 0:03:24.200 --> 0:03:27.960 bank funding stress and ultimately the stability of financial institutions. 0:03:28.000 --> 0:03:31.800 So when library started to move and other short term 0:03:31.880 --> 0:03:36.120 rates like FED policy expectations did not, and that spread, 0:03:36.160 --> 0:03:39.320 that difference widened out, it ended up being a really 0:03:39.360 --> 0:03:42.480 important forward looking indicator for the for the problems that 0:03:42.480 --> 0:03:45.320 we're gonna come and ultimately led to bailouts and a 0:03:45.360 --> 0:03:48.920 couple of near or actual bankruptcies, and and all of 0:03:48.960 --> 0:03:51.560 the problems that the financial system was facing we're kind 0:03:51.560 --> 0:03:57.040 of pre presaged by moves in liborary. So that's been 0:03:57.080 --> 0:03:59.320 something people have watched for a while, and there have 0:03:59.360 --> 0:04:03.320 been episode is over the past twelve years where library 0:04:03.360 --> 0:04:05.560 was once again in the spotlight. And the best example 0:04:05.600 --> 0:04:08.720 of that was the European sovereign funding stress episodes of 0:04:09.400 --> 0:04:13.920 and twelve UM, when initially Greece and ultimately Italy in 0:04:13.960 --> 0:04:19.200 Spain we're coming under stress. Their banks were either directly 0:04:19.279 --> 0:04:23.520 or or or implicitly part of the libar panel um 0:04:23.520 --> 0:04:26.039 and we can talk about that as well, but the 0:04:26.080 --> 0:04:28.880 banks in Europe were all interconnected to some extent, and 0:04:28.960 --> 0:04:32.080 problems in Italy and Italian banks were ultimately problems for 0:04:32.640 --> 0:04:35.480 German and French banks, and that went into the librar 0:04:35.600 --> 0:04:39.560 fixing and library oh I s so I s being 0:04:39.600 --> 0:04:42.960 fed funds, you know, fed policy expectations. The difference between 0:04:42.960 --> 0:04:46.680 these two rates widened out quite a bit, so that 0:04:46.720 --> 0:04:50.120 was ultimately like something people watched, is this financial stability 0:04:50.600 --> 0:04:54.920 financial conditions indicator. Uh. More recently, we we saw an 0:04:54.920 --> 0:04:58.120 even larger widening in the in library versus O I 0:04:58.279 --> 0:05:01.720 S back in March, and so that was really the 0:05:02.080 --> 0:05:04.520 largest movement that spread since two thousand eight. And it 0:05:04.640 --> 0:05:09.240 was immediately questions as to whether this was another canary 0:05:09.240 --> 0:05:12.280 in the cold mine, meaning, you know, libras is widening up. 0:05:12.320 --> 0:05:14.480 Does that mean as much as the banks are telling 0:05:14.560 --> 0:05:16.800 us that everything's fine and we're better capitalized and we're 0:05:16.839 --> 0:05:18.800 more stable and we have all this high quality liquid 0:05:18.800 --> 0:05:22.680 asset stock to rely upon to raise liquidity, like are 0:05:22.720 --> 0:05:25.880 we actually in trouble and the market knows about it, 0:05:25.920 --> 0:05:30.239 but maybe the public doesn't get and and that's priced 0:05:30.279 --> 0:05:33.599 into the library. So, um, this was one of the 0:05:33.640 --> 0:05:37.840 two or three things that was really closely watched by 0:05:37.880 --> 0:05:40.560 a variety of people and ultimately, you know, the public 0:05:40.640 --> 0:05:43.880 because you problems with banks or problems for the economy, 0:05:44.000 --> 0:05:47.679 especially in a major economic shock at the same time. 0:05:48.240 --> 0:05:52.600 Um So, so then all the questions really surrounded what 0:05:52.760 --> 0:05:56.080 was actually driving this move and librar was Librard telling 0:05:56.120 --> 0:05:59.080 us something about the banking system or was Livebrard telling 0:05:59.160 --> 0:06:02.360 us something about the way that we construct live RRE. 0:06:02.360 --> 0:06:05.800 Now that's much more technical and frankly less interesting to 0:06:05.880 --> 0:06:08.520 the broader public. Um. And it turned out to be 0:06:08.640 --> 0:06:13.599 mostly glad to explain that further. I mean, actually, when 0:06:13.600 --> 0:06:16.760 we talked to you last time, which we've actually been 0:06:16.839 --> 0:06:19.080 at the very end of March or maybe early April, 0:06:19.160 --> 0:06:22.480 we still were right in the thick of the volatility. 0:06:22.520 --> 0:06:25.320 But a lot of that conversation was about what was 0:06:25.360 --> 0:06:28.120 going on, not with the banks per se, but with 0:06:28.920 --> 0:06:33.039 other entities that were trading treasuries and trading futures and 0:06:33.080 --> 0:06:38.520 the illiquidity in that space. So from your perspective, what 0:06:38.520 --> 0:06:43.000 what was librar, What was that widening really telling us? 0:06:43.000 --> 0:06:45.040 And what did it have to do with the volatility 0:06:45.040 --> 0:06:48.360 at the time. Yeah, so's ultimately the question is what 0:06:48.480 --> 0:06:51.200 are we really seeing when we see a live RAR fixing. 0:06:51.240 --> 0:06:54.320 Let's say today library is thirty five basis points? Like, 0:06:54.400 --> 0:06:56.760 what what is that number? What goes into that number? 0:06:57.360 --> 0:06:59.240 In the pre crisis days where there was a lot 0:06:59.279 --> 0:07:03.960 of interbank trading, of of short term lending and so forth, 0:07:04.040 --> 0:07:07.760 like library had actual transactions behind it because banks would 0:07:07.800 --> 0:07:11.040 do those short term loans relative to each other. Um. 0:07:11.120 --> 0:07:12.800 But you know, somewhat tongue in cheep, we say, these 0:07:12.880 --> 0:07:14.800 days there's no eye and library. The eye stands for 0:07:14.880 --> 0:07:18.000 inter bank and there's no interbank trading. Where there's no 0:07:18.040 --> 0:07:22.760 significant interbank trading, and so the Intercontinental Exchange is that 0:07:23.160 --> 0:07:26.600 is the benchmark administrator. They put out a couple of 0:07:26.640 --> 0:07:30.560 years ago revised guidance for panelists as to how this 0:07:30.680 --> 0:07:33.560 submit their quotes, so to quickly review your library. Is 0:07:34.040 --> 0:07:37.400 this panel of banks, large international banks that are active 0:07:37.400 --> 0:07:40.320 in short term markets. Every day they're asked where they 0:07:40.320 --> 0:07:42.760 think they can borrow, and they're supposed to put in 0:07:42.760 --> 0:07:45.480 a number, And you don't have the option to just pass, 0:07:45.840 --> 0:07:48.280 so you have to put a number in every day. Um. 0:07:48.320 --> 0:07:51.560 It's easy to put in a number if you spending 0:07:51.640 --> 0:07:54.680 borrowed money that day. Um. And that was very frequently 0:07:54.680 --> 0:07:56.960 the case in in the sort of two thousand and 0:07:57.000 --> 0:08:00.120 two thousand eight period um, and even earlier than that. 0:08:00.360 --> 0:08:03.280 The problem is now, because there's not much inter bank 0:08:03.960 --> 0:08:07.080 lending and borrowing, they're forced to rely on the commercial 0:08:07.080 --> 0:08:09.760 paper market. So the question is did I issue commercial 0:08:09.800 --> 0:08:13.440 paper or a certificate of deposit today? Um? And if 0:08:13.480 --> 0:08:15.040 I did, then I've got a really great way to 0:08:15.040 --> 0:08:17.560 make my quote because I borrowed money today, let's say 0:08:17.640 --> 0:08:20.559 borrowed at forty basis points. So I tell the ice 0:08:21.360 --> 0:08:24.080 that I borrowed at forty basis points. But when we 0:08:24.120 --> 0:08:26.720 look back over the past year or so, on average 0:08:27.000 --> 0:08:31.000 of the sixteen panelists, only say four or five on 0:08:31.040 --> 0:08:35.439 average are doing that on a given day. So what 0:08:35.480 --> 0:08:38.480 do I do if I don't have a transaction to 0:08:38.520 --> 0:08:41.839 point to? And the the ICE released what they called 0:08:41.840 --> 0:08:45.760 the Waterfall, basically a prioritized list of other things you 0:08:45.800 --> 0:08:48.800 can look at, uh to come up with a number 0:08:48.840 --> 0:08:51.240 that's supposed to be like close to where you could borrow, 0:08:51.679 --> 0:08:55.080 but you're inferring it, you're not actually observing it. So 0:08:55.920 --> 0:08:58.000 one of the interesting things that happened to lieb Or 0:08:58.240 --> 0:09:02.679 in March was it it hit a pretty sharp peak. 0:09:02.840 --> 0:09:04.480 I think it was something like I want to say, 0:09:04.559 --> 0:09:08.640 one point four or one point five, and then it 0:09:08.679 --> 0:09:12.679 took quite a long time to sort of start coming down, 0:09:12.920 --> 0:09:16.160 even though the Federal Reserve was unveiling all these new 0:09:16.200 --> 0:09:21.200 programs to inject liquidity into the economy. The technical dynamics 0:09:21.200 --> 0:09:25.880 that you're describing, is that something that would um, I guess, 0:09:26.000 --> 0:09:30.960 prevent a central bank stimulus measures or monetary easing from 0:09:31.000 --> 0:09:35.520 impacting the library as well. Yeah, there's definitely a policy 0:09:35.559 --> 0:09:38.720 transmission issues. So when the Fed moves interest rates around, 0:09:39.160 --> 0:09:42.200 they're ultimately trying to stimulate the economy through the cost 0:09:42.280 --> 0:09:46.560 of loans. The problem is they target the federal funds rate, 0:09:46.760 --> 0:09:48.360 and there's not a ton of loans tied to the 0:09:48.360 --> 0:09:50.760 federal funds rate. So when the Fed moves interest rates, 0:09:51.200 --> 0:09:54.080 they rely on the relationship between that that federal funds 0:09:54.160 --> 0:09:57.520 rates and other interest rates to to actually sort of 0:09:57.559 --> 0:10:00.319 get the stimulus into the real economy. And I'm sure 0:10:00.320 --> 0:10:02.800 your other guests spoke about the live war is by 0:10:02.840 --> 0:10:06.160 far the most pervasive of those interest rates, so to 0:10:06.240 --> 0:10:08.520 some extent, if it doesn't get passed through the library, 0:10:09.160 --> 0:10:11.319 then it doesn't have nearly the same effect. And when 0:10:11.320 --> 0:10:14.360 the Fed cut rates a hundred basis points, library didn't 0:10:14.400 --> 0:10:17.240 really move in March, and so you didn't really have 0:10:18.200 --> 0:10:22.160 a ton of stimulus, at least immediately into the economy. 0:10:22.160 --> 0:10:24.680 There's also the question of whether interest rates were really 0:10:24.760 --> 0:10:27.520 the thing that was causing issues, which I think is 0:10:27.559 --> 0:10:30.840 a different conversation for somebody with more economics training than me. 0:10:31.200 --> 0:10:33.000 But but if we say the Feds trying to do 0:10:33.000 --> 0:10:35.760 what they can, lowering interest rates is the is the 0:10:35.760 --> 0:10:39.360 most straightforward and classic thing they can do. If that's 0:10:39.360 --> 0:10:42.160 not passed through the live or because of these technical issues, 0:10:43.000 --> 0:10:45.480 you've got a problem. And so you know, it was 0:10:45.520 --> 0:10:47.079 kind of alluding to earlier is that there weren't a 0:10:47.080 --> 0:10:50.520 lot of transactions. And when we talked in April, one 0:10:50.520 --> 0:10:53.440 of the issues was that the capital markets essentially shut down. 0:10:53.720 --> 0:10:57.559 So what was typically four or five panelists issuing commercial 0:10:57.600 --> 0:10:59.800 paper on a given day, which is again pretty small 0:10:59.800 --> 0:11:02.960 for action of total number of panelists. Uh, that number 0:11:02.960 --> 0:11:05.720 went to like two or three when when library was rising. 0:11:06.120 --> 0:11:09.640 So the rise in library to a large extent reflected 0:11:09.800 --> 0:11:12.840 other kinds of funding stress that are not really tied 0:11:13.400 --> 0:11:16.440 to like bank credit. So this wasn't really about the 0:11:16.480 --> 0:11:20.160 ability of banks to repay loans because of the risk 0:11:20.200 --> 0:11:23.840 of bankruptcy or failure. It was about the cost of 0:11:23.920 --> 0:11:27.240 securing dollars through other sources and just the scarcity of 0:11:27.280 --> 0:11:30.040 dollar funding in general, which is a very different thing 0:11:30.080 --> 0:11:34.640 and frankly much less concerning for overall financial stability. Because 0:11:34.640 --> 0:11:37.760 the bank credit is in question that has all kinds 0:11:37.800 --> 0:11:40.680 of knock on consequences for the economy, which we learned 0:11:40.679 --> 0:11:43.960 about in two thousand two nine. Well, so, okay, so 0:11:44.840 --> 0:11:49.880 in March, the rise in the library didn't necessarily reflect 0:11:49.960 --> 0:11:51.720 what was going on with bank credit, which is good. 0:11:52.080 --> 0:11:54.920 But in terms of its function as a benchmark for 0:11:54.960 --> 0:11:58.920 all kinds of loans and derivatives and other instruments, was 0:11:58.960 --> 0:12:02.000 it still basically serving its purpose if it was a 0:12:02.040 --> 0:12:06.440 measure of overall funding conditions or funding stress elsewhere in 0:12:06.480 --> 0:12:11.000 the financial system, that doesn't necessarily strike me as a 0:12:11.040 --> 0:12:14.000 bad measure to still use if we're going for live 0:12:14.120 --> 0:12:17.360 Or's main purpose. Well, so I guess when we think 0:12:17.360 --> 0:12:19.400 about live or, like what is it supposed to do? 0:12:19.559 --> 0:12:21.400 Like why do we make an index out of bank 0:12:21.600 --> 0:12:24.360 borrowing in the first place, Because we could have just 0:12:24.400 --> 0:12:27.280 tied everything to FED funds or or the prime rate, 0:12:27.320 --> 0:12:30.440 like we have the prime rate. That's an alternative um. 0:12:30.480 --> 0:12:34.880 And when we initially constructed live Or, the idea was, 0:12:35.480 --> 0:12:37.480 you know, I need some kind of credit components. So 0:12:37.600 --> 0:12:39.520 using Fed funds of the prime rate is not a 0:12:39.600 --> 0:12:43.440 great measure because like this is a benchmark against which 0:12:43.600 --> 0:12:47.440 loans to individuals and corporations it's getting measured. So I 0:12:47.480 --> 0:12:51.280 want some elements of underlying credit risk in this index. 0:12:52.280 --> 0:12:55.760 So who's the best credit around? Arguably it's it's the 0:12:55.880 --> 0:12:59.520 largest international banks. So the question is, if I want 0:12:59.520 --> 0:13:01.880 to borrow any I Josh, want to take out an 0:13:01.880 --> 0:13:08.240 adjustable rate mortgage, my credit is bases points worse than 0:13:08.280 --> 0:13:10.360 a good bank, right, And so I have this like 0:13:10.440 --> 0:13:14.800 benchmark that's tied to ultimately private market, you know, credit 0:13:14.800 --> 0:13:18.520 exposed institution, but one that's kind of high up on 0:13:18.559 --> 0:13:22.640 the on the scale of qualities of credit. Um so 0:13:24.160 --> 0:13:27.200 when you have live or moving because of broader funding 0:13:27.200 --> 0:13:30.520 market conditions, and that really means the ability to find 0:13:30.559 --> 0:13:33.640 those lendable dollars the very technical thing, right, I mean, 0:13:34.160 --> 0:13:36.760 if you're unconcerned about getting your money back, but you 0:13:36.840 --> 0:13:38.880 just don't have the dollars to lend because they're locked 0:13:38.920 --> 0:13:40.640 up somewhere else, so you can't pass them through the 0:13:40.640 --> 0:13:43.520 pipes effectively. Like, is that really the benchmark we want 0:13:43.520 --> 0:13:49.000 to use for adjustable rate mortgages, for corporate debt, for 0:13:49.559 --> 0:13:52.679 corporate loans, for for the main street lending facility. And 0:13:53.040 --> 0:13:56.280 so the question is is not whether or not these 0:13:56.320 --> 0:14:00.520 disruptions happened, because you know, any imperfect measure is going 0:14:00.559 --> 0:14:03.360 to have issues occasionally. The question is is this something 0:14:03.440 --> 0:14:05.760 I can expect to persist over long periods of time? 0:14:06.240 --> 0:14:07.920 Is it going to lead to a lot of volatility 0:14:08.360 --> 0:14:11.520 in interest rates that's not really reflective of the credit markets, 0:14:11.559 --> 0:14:14.280 And so am I sort of creating more trouble than 0:14:14.320 --> 0:14:16.959 it's it's worth and in tying the lending market or 0:14:16.960 --> 0:14:20.400 continuing to tie it to this bank credit index that's 0:14:20.440 --> 0:14:35.640 constructed in this in perfect way. So I think you 0:14:35.840 --> 0:14:39.640 actually coined the term zombie liabor. I think you were 0:14:39.680 --> 0:14:43.440 writing about that possibility back in September when you look 0:14:43.440 --> 0:14:45.760 at what was happening in March, where you know, you 0:14:45.800 --> 0:14:48.440 didn't have a lot of these lending transactions on which 0:14:48.440 --> 0:14:52.120 to actually base libror. Do you think the risk of 0:14:52.280 --> 0:14:55.400 ending up with zombie library, as you put it, is 0:14:55.440 --> 0:14:58.320 increased or that there's proof that we're sort of heading 0:14:58.360 --> 0:15:02.200 in that direction. Well, the zombie library outcome, and just 0:15:02.240 --> 0:15:05.360 to review that, that's a scenario in which you have 0:15:05.440 --> 0:15:09.040 this panel of sixteen banks, and starting in the beginning 0:15:09.040 --> 0:15:11.880 of two the regulators are going to allow banks to 0:15:12.240 --> 0:15:14.320 drop off the panel. They're no longer going to compel 0:15:14.840 --> 0:15:16.920 membership because at the moment, if you want to get 0:15:16.920 --> 0:15:19.440 off the library panel, it's actually not so easy to do. 0:15:19.520 --> 0:15:21.960 And they're doing that because they need a decent number 0:15:21.960 --> 0:15:24.400 of banks to get a decent sample in that in 0:15:24.440 --> 0:15:27.760 that index. And so when people talk about librars quote 0:15:27.800 --> 0:15:33.600 unquote going away at the end of two, what they're 0:15:33.640 --> 0:15:36.600 referencing is is the f c A, the Financial Conduct 0:15:36.600 --> 0:15:40.280 Authorities statement that they will no longer compel membership. And 0:15:40.320 --> 0:15:42.520 so the presumption is if you don't have to stay 0:15:42.520 --> 0:15:44.120 in that club to which you would not like to 0:15:44.200 --> 0:15:48.240 join or remain, you'll leave UM. And and there's lots 0:15:48.240 --> 0:15:50.560 of reasons why why one would want to leave that 0:15:50.560 --> 0:15:54.880 that particular panel, and so zombie Library is a scenario 0:15:55.000 --> 0:15:59.320 where a lot of banks leave, but not everybody does, 0:15:59.440 --> 0:16:02.400 and your left with a kind of small contingent of 0:16:02.520 --> 0:16:06.080 say five or six submitters, and that leads to a 0:16:06.120 --> 0:16:08.360 lot of volatility, because if you pick the wrong set 0:16:08.360 --> 0:16:10.680 of five, you could end up with a much more 0:16:10.760 --> 0:16:15.400 volatile index. What thankfully, there's kind of a regulatory solution 0:16:15.440 --> 0:16:18.600 to this. So UM if the f c A and 0:16:18.600 --> 0:16:22.440 and the benchmark Administrator coordinate to some extent um, they 0:16:22.440 --> 0:16:24.800 can come up with a scenario where the f c 0:16:24.920 --> 0:16:29.320 A deems Library nonrepresentative, and instead of continuing to post 0:16:29.320 --> 0:16:33.120 fixings because the ice the benchmark administrator, they're under no 0:16:33.280 --> 0:16:36.880 obligation to keep posting Library or to stop posting Library, 0:16:36.920 --> 0:16:39.880 but the SEA can simply say they don't think it's representative, 0:16:39.920 --> 0:16:43.120 but you can keep producing fixings. Um. They have come 0:16:43.160 --> 0:16:44.680 together and said, look, we're not going to do that. 0:16:45.360 --> 0:16:49.680 If if the f c A says Library has entered 0:16:49.680 --> 0:16:51.880 a stage where it just is no longer representative of 0:16:51.920 --> 0:16:55.360 credit markets, then we the benchmark administrator, will stop publishing 0:16:55.360 --> 0:16:58.800 it pretty soon thereafter. So I'm sort of less concerned 0:16:58.840 --> 0:17:04.400 about that at the moment because of that coordination. UM. 0:17:04.680 --> 0:17:06.960 And that's a good thing because like all of the 0:17:07.040 --> 0:17:09.240 rules and will probably talk about fallbacks and all these 0:17:09.240 --> 0:17:13.159 other things, like if Library is still getting produced, unless 0:17:13.200 --> 0:17:16.199 you specifically account for that scenario, you could end up 0:17:16.200 --> 0:17:18.560 in a situation where you keep having a reference a 0:17:18.680 --> 0:17:22.960 rate that is increasingly problematic. And Library has its problems now, 0:17:23.080 --> 0:17:26.800 but there's sixteen contributors, imagine there were five or six, 0:17:27.080 --> 0:17:31.840 and and all the problems would be magnified. So just 0:17:31.920 --> 0:17:34.240 while we're talking about the events of the last couple 0:17:34.240 --> 0:17:36.040 of months, I mean, one of the things is this 0:17:36.160 --> 0:17:38.359 series has gone on. We've talked about the various steps, 0:17:38.359 --> 0:17:41.240 the difficulty and transition. Of course, we wanted to get 0:17:41.240 --> 0:17:45.840 your broader perspective on that. But have there been any 0:17:45.880 --> 0:17:49.919 substantive ways in which what we've seen since the beginning 0:17:49.960 --> 0:17:54.640 of this crisis has changed the planning and overall trajectory. 0:17:55.000 --> 0:17:58.520 So it hasn't changed the planning. The question is how 0:17:58.640 --> 0:18:00.800 we I think it comes back to the of like, 0:18:00.840 --> 0:18:03.080 how are you actually going to do this thing? Meaning 0:18:03.680 --> 0:18:05.760 we can say we want to get off of live 0:18:05.880 --> 0:18:07.840 or we can threaten to get rid of lib or, 0:18:08.480 --> 0:18:11.480 But unless all the pieces are in place, that's a 0:18:11.600 --> 0:18:15.119 pretty risky proposition because you're now talking about ripping out 0:18:15.480 --> 0:18:20.080 one of the central elements of the financial system UM 0:18:20.080 --> 0:18:23.920 in a pretty rapid fashion. Io is not that far away, 0:18:24.040 --> 0:18:26.240 and so you've really got to make sure that you've 0:18:27.200 --> 0:18:30.440 kind of ring fence the potential risks around doing that, 0:18:30.480 --> 0:18:33.640 because I think we can all agree like, under normal circumstances, 0:18:33.640 --> 0:18:36.840 you don't want to destabilize the vast majority of the 0:18:36.920 --> 0:18:39.040 lending and derivatives markets, and you definitely don't want to 0:18:39.040 --> 0:18:42.520 do that now. So what about March has made that 0:18:42.560 --> 0:18:45.040 either more or less likely getting those pieces in place 0:18:45.680 --> 0:18:48.119 to actually get to the to the point where we 0:18:48.160 --> 0:18:50.199 can we can say we're off of live RAR and 0:18:50.240 --> 0:18:53.320 specifically stop publishing it, because if you're to do that now, 0:18:53.880 --> 0:18:56.600 you'd have a lot of problems. Um. So the first 0:18:56.600 --> 0:18:59.040 thing you gotta do is you've got to come up 0:18:59.040 --> 0:19:02.000 with fallback language, which that takes care of the fact 0:19:02.080 --> 0:19:06.440 that when most of the existing loans and derivatives were written, 0:19:07.359 --> 0:19:11.080 they didn't really contemplate a permanent end to live or. So. 0:19:11.200 --> 0:19:15.480 My my favorite example of this is in some some 0:19:15.560 --> 0:19:17.920 notes that are floating interest rate which is supposed to 0:19:17.920 --> 0:19:20.840 observe library every quarter. Um. They say, well, if there's 0:19:20.880 --> 0:19:23.440 no live or today, look at the last valid live 0:19:23.520 --> 0:19:25.920 orre fixing you can find and use that to calculate 0:19:25.920 --> 0:19:28.679 the payment, which makes total sense if you think it's 0:19:28.680 --> 0:19:32.440 a day or two, but not if it's going away forever. So. Um, 0:19:32.480 --> 0:19:35.040 if you own a security that's supposed to pay you 0:19:35.040 --> 0:19:39.200 whatever library is now and library goes away, you're taking 0:19:39.200 --> 0:19:41.159 the risk that, like library goes away at a very 0:19:41.200 --> 0:19:42.879 low interest rate level, you just don't know, like we 0:19:42.920 --> 0:19:44.520 don't know what librar is going to be in the future, 0:19:44.920 --> 0:19:47.080 and so that's rolling the dice in a way that's 0:19:47.080 --> 0:19:50.280 not particularly appealing. Um. And if you go to the 0:19:50.320 --> 0:19:52.760 drivaters market, which one of your other guests might have 0:19:52.840 --> 0:19:55.560 mentioned scales and stuff like that. But two trillion dollars 0:19:55.640 --> 0:19:59.679 is a lot of money, um, and those payments have 0:19:59.800 --> 0:20:02.080 been start to live bar. And the way those fallbacks 0:20:02.119 --> 0:20:04.640 were initially set up was they said, well, if live 0:20:04.640 --> 0:20:07.520 Board is not there today, then pick up the phone 0:20:07.520 --> 0:20:09.680 and call people and try to get them to quote 0:20:09.680 --> 0:20:12.879 you a level on a more informal basis. And I 0:20:12.880 --> 0:20:15.160 think it's fair to say that if banks don't want 0:20:15.160 --> 0:20:17.760 to be in the Liveboard panel for variety of reasons 0:20:17.800 --> 0:20:21.399 including you know, liability and so forth, um, they definitely 0:20:21.440 --> 0:20:23.040 don't want to be picking up the phone and just 0:20:23.119 --> 0:20:27.040 quoting something in an informal way. So um, in the 0:20:27.080 --> 0:20:30.560 case where you can't actually source informal quotes, then you're 0:20:30.640 --> 0:20:32.320 kind of at a dead end, which means there is 0:20:32.359 --> 0:20:35.520 no number with which to calculate the coupon payments on 0:20:35.560 --> 0:20:40.200 two trillion dollars of notional worth of derivative contracts, which, um, 0:20:40.240 --> 0:20:41.399 you know, if you were a lawyer, that would be 0:20:41.400 --> 0:20:43.000 a great set up, but for the rest of us, like, 0:20:43.080 --> 0:20:46.199 that's not a great um situation to be in. And 0:20:46.240 --> 0:20:50.840 so like, the key is to amend all of these contracts, 0:20:51.240 --> 0:20:54.639 not just derivatives and loans, but also mortgages and the 0:20:54.720 --> 0:20:58.639 variety of other things to make sure they have, you know, 0:20:58.720 --> 0:21:02.760 clauses that take care of this eventuality. And and so 0:21:02.840 --> 0:21:06.640 that's the is to fall back protocol process. It sort 0:21:06.680 --> 0:21:09.880 of serves two purposes, is that being the Derivatives UM 0:21:10.040 --> 0:21:14.000 Industry Organization is putting forward standard language for all derivative 0:21:14.440 --> 0:21:16.600 contracts take care of this. And what they're doing is 0:21:16.600 --> 0:21:20.959 they're using a historical observation of live orar versus SOFA, 0:21:21.080 --> 0:21:23.800 the secured overnight financing rate the replacement for lib orary. 0:21:23.960 --> 0:21:26.520 So look at the difference between those two things, look 0:21:26.520 --> 0:21:29.119 at its historical average, and now what you thought was 0:21:29.119 --> 0:21:33.040 gonna be library is now you know, sofur plus this 0:21:33.200 --> 0:21:36.520 spread that we're going to observe over the past five years, 0:21:36.680 --> 0:21:40.760 let's say, UM. So that's great for the derivatives market. 0:21:41.119 --> 0:21:44.600 And they're they're close to putting out the triggering terms 0:21:44.680 --> 0:21:48.320 like under what circumstances do you do this specifically, how 0:21:48.320 --> 0:21:51.160 do you actually calculate this spread, etcetera. And and they're 0:21:51.200 --> 0:21:53.720 close to being done with that. And the key there 0:21:53.800 --> 0:21:58.320 is that once you have a standard UM language, you 0:21:58.359 --> 0:22:01.240 can incorporate it into other things. So a lot of 0:22:00.720 --> 0:22:03.600 the push has been to make sure that all of 0:22:03.640 --> 0:22:07.280 the cash products, all the securities and loans and and 0:22:07.280 --> 0:22:12.840 and other non derivative instruments basically align with whatever language 0:22:12.840 --> 0:22:15.919 is that comes up with because then you have a 0:22:16.000 --> 0:22:19.760 single industry standard. That's a good thing. UM. Just less 0:22:19.800 --> 0:22:23.080 to argue about. UM. The only thing is that the 0:22:23.119 --> 0:22:26.120 hedges that are used to manage risk associated with those 0:22:26.160 --> 0:22:30.439 investments are going to have the same fallbacks because the 0:22:30.520 --> 0:22:34.760 last thing you want. You think about a large financial institution, UM, 0:22:34.840 --> 0:22:38.400