QOTD -- LIBOR: ESMA Speaks
ICYMI on Friday, the Chairman of the European Securities and Markets Authority (ESMA) delivered a speech regarding the LIBOR transition. The majority of his remarks, however, focused on the parallel reform efforts regarding euro-denominated market benchmarks:
While providing reassurances regarding the reform process in the EuroArea, the speech inadvertently highlights an underappreciated element of the benchmarks reform process: the inter-bank offer rate will remain in place in the EuroArea even as it disappears completely in other jurisdictions.
This structural divergence globally creates real challenges for risk managers as well as compliance officers seeking to automate their transition implementation internally. Adjusting to a new risk-free benchmark involves far more than a "cut and paste" initiative for legacy contracts.
Risk measurement systems applicable to benchmarks based only on market prices require a different architecture than those applicable to inter-bank offer rates that remain in operation. Over time, the benchmarks themselves may also demonstrate divergences in response to monetary policy as well as regulatory policy shifts.
The LIBOR transition requires a keen appreciation for the policy risk components that govern not only the shift towards new benchmarks but also ongoing potential policy shifts that respond to market behavior. We can help with that.
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