Unpopular but transparent FX swap method to become mainstream by next year says senior JP Morgan trader

Almost exactly a year ago, the very first risk-free-rates (RFR) currency swap was traded between Morgan Stanley and Goldman Sachs for both legs of the trade, just shortly after the method had been introduced.

Back in November 2019, when that particular EURUSD trade was reported to the Depository Trust & Clearing Corporation’s (DTCC), it marked a potential move toward attempts to remove the soon to be extinct LIBOR family of reference rates.

Here we are, one year later, and the RFR swap method for both legs of interbank trades has not become widely used, and banks, regulators and financial markets participants are working hard toward preparing for the discontinuation of LIBOR and the implementation of its replacement.

Now, as cross-currency swap markets have yet to embrace alternative risk-free rates (RFRs), such as the US secured overnight financing rate (SOFR), these overnight benchmarks will become the standard on both legs of a trade by the end of next year, according to a Tom Prickett, co-Head of EMEA Rates at J.P. Morgan.

A year after the first RFR-linked cross-currency swaps were stuck across various currency pairs and reported to the DTCC on November 21, 2019, reported volumes remain sparse, with the majority of volume still transacted using Libor rates on both legs of trades.

In August this year, Mr Prickett elaborated on the efforts being made to move away from LIBOR as a reference rate system and move to alternative methods.

Mr Prickett spoke out on this just after Eurex Clearing cleared its first SOFR swaps transactions on August 7, in which initial trades were submitted by J.P. Morgan and LBBW, a development which Mr Prickett oversaw. SOFR Overnight Index Swaps and SOFR Basis Swaps (both SOFR versus Fed Funds and SOFR versus USD Libor) have been clearable at Eurex Clearing up to a 50-year maturity since July 29, 2020.

At that time, Thilo Roßberg, head of FICC Markets at LBBW, said in a statement: “Clearing the first USD SOFR swaps at Eurex Clearing demonstrates our commitment to the development of an alternative European based liquidity pool.”

Mr Prickett said in August this year “Being the first to clear USD SOFR swaps at Eurex Clearing demonstrates our commitment to provide liquidity and support our European clients with their multi-currency derivatives clearing needs. This is another important milestone in the benchmark transition process and we’re delighted to be leading our clients through this positive industry change.”

Phil Simons, global head of Fixed Income Sales, Derivatives, Funding and Financing at Eurex Clearing, said in a statement: “Making it possible for clients to combine EUR and USD swap clearing attracts even more clients to our EU27 based, EMIR compliant liquidity pool. It is another vital step in our vision to become home of the euro yield curve.”

In 2017, the Alternative Reference Rate Committee (ARRC) identified a viable alternative to USD Libor by selecting the Secured Overnight Financing Rate (SOFR). The Federal Reserve Bank of New York began publishing the rate in April 2018 in its efforts to replace LIBOR and as the preferred alternative reference rate for the USD marketplace. SOFR is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities.

It is rather encouraging to see banks looking to proactively seek out new methods of rating. This represents an absolute U-Turn from where many Tier 1 FX interbank dealers were a few years ago, when some of their traders were members of cartels which used messaging systems to interfere with the benchmark rates and LIBOR for their own benefit.

Many of the culprits now languish in jail, and the banks concerned were fined tremendous amounts of money by North American, British and Swiss regulators in the most high profile FX dealing scandal in history.

If Mr Prickett’s prediction is correct, we may be on the way to a transparent future. Now we just need to get their last-look antics sorted out…