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IBOR Transition and Value Transfer

We took an inside look at the recent EONIA to €STR switch and its implications for the upcoming USD PAI discounting switch from Fed Funds to SOFR in October.

The recent EUR Price Alignment Interest (PAI) and discounting switch from EONIA to €STR for cleared derivatives is now in the books. From 27 July 2020, any EUR cleared swap or EUR swaption delivering a cleared swap follows the conventions set by the clearing houses (e.g.CME, Eurex, LCH) and €STR is now the standard rate for discounting those instruments. The new EUR PAI and discounting conventions delivered €STR discounting risk to all parties involved in cleared derivatives. It is expected that the upcoming USD PAI and discounting switch from Fed Funds (or EFFR, Effective Federal Funds Rate) to SOFR planned for 17 October 2020 will be far more complex due to the size of the USD cleared derivatives market, the number of firms involved and the fact that the Fed Funds and SOFR basis is dynamic which complicates compensation mechanisms involving the delivery of basis swaps to address changes in risk profile. It is critical that firms with significant exposure look at value transfer considerations and assess the impact of this discounting switch on their portfolios. Taking a proactive approach and monitoring liquidity and PV impact of transitioning trades, portfolios and CSAs is critical. If liquidity is too low and PV impact is unfavorable, it might be preferable to wait. If liquidity is good and PV impact is favorable, the transition should happen now. If you'd like to discuss further with our team of experts at IHS Markit, please reach out.

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