Opening the buy-side liquidity pool - Q&A with Vikash Rughani

Vikash Rughani: As cessation timelines become clearer, triReduce has moved forward to the next stage of facilitating the transition to new benchmarks.

To help market participants mitigate risk in the transition of legacy interest rate benchmark contracts, TriOptima operates regular portfolio compression cycles, bringing together buy- and sell-side participants to primarily compress their existing legacy benchmark trades. These compression cycles can also act as the nucleus of a liquidity pool that will be essential for delivering new conversion methodologies for migrating away from legacy benchmarks for over-the-counter (OTC) derivatives. 

Building on the foundation of these compression cycles, TriOptima has introduced benchmark conversion functionality to offer a unique opportunity for new buy-side entities that traditionally may not have been involved in portfolio compression – hedge funds and asset managers with directional portfolios, for example – to join our established network of compression participants in converting their remaining legacy benchmark transactions once new trading activity switches to the alternative benchmarks. The addition of these new participants will be crucial to the success of benchmark conversion because they bring further cashflow and risk offsets – which itself are crucial in maintaining the central counterparty’s (CCP’s) cashflow neutrality.

This is akin to a market participant needing to execute a new transaction that is equal and opposite to their original position to compress its position in the CCP directly. In multilateral services such as ours, the strength of the network provides the mechanism for finding offsets that already exist as opposed to having to execute new transactions with liquidity providers – therefore having the potential to reduce the cost of risk mitigation.

Performing these benchmark conversion exercises iteratively over time means TriOptima can help the market achieve a mass conversion from legacy benchmarks into alternative reference rates (ARRs).

Vikash Rughani: triReduce benchmark conversion is currently available in our LCH & JSCC interest rate compression cycles. In the coming months, our CME compression cycles will begin to benefit from this added functionality as will our bilateral interest rate and cross-currency swap cycles.

Benchmark conversion will be offered in all currencies as alternative risk-free rate (RFR) transition plans take effect. Having gone live in GBP, JPY and most recently EUR, we are working with participants to test this functionality for CHF, SGD & USD.

Vikash Rughani: Firms adopting the most sophisticated form of Benchmark Conversion, including support for risk replacement trades on the alternative benchmarks, are seeing up to 40% more post-cessation legacy benchmark exposure reduced on average compared to those participants that have yet to adopt risk replacement trades. However, due to the nature of the network service, all participants are seeing some benefit of additional post-cessation exposure reduction.

Vikash Rughani: After firms register for a specific compression cycle, TriOptima receives their trade population in that currency from the CCP. Participants then send us their ID’s for the trades they are interested in compressing. In response, we will suggest trades to either terminate, amend or replace using risk-replacement trades having accounted for their submitted PV & risk as well as the limits they place on the amount of change ther are willing to accept in those submitted values. The outcome is that each submitted trade is either left untouched, terminated fully or amended in some way, such as a change to the notional, the direction, the spread or the coupon. Risk replacement trades on the new alternative benchmark may also be proposed as a result of the exercise.

All participants gain access to the same secure platform and risk-based constraints, whilst the entire exercise is performed under each participant’s own valuations and risk sensitivities. Those constraints are defined by each firm within their own risk appetite levels. This combination means there’s no uncertainty when firms verify the risk impacts in their own system.

Vikash Rughani: Firstly, triReduce Benchmark Conversion is entirely voluntary and is only performed on submitted trades where the risk constraints enable compression or conversion to occur for legacy benchmark exposure reduction.

Secondly, the resulting trades will not exhibit a spread on the float leg to align them with fallen-back swaps converted by the CCP or in the bilateral market. Instead, triReduce’s objective has been to replace the interest rate risk onto true market standard OIS trades for maximum compressibility and ease of subsequent margin management. Having said that, TriOptima is happy to consider participants that may prefer to maintain coupon payment frequency between their legacy benchmark trades and the resulting alternative RFR OIS trades.

Lastly, the compression & conversion will be performed at each participant’s own mid-market valuations and constrained by their own risk values and constraints in an iterative manner over time, rather that on a single date ahead of index cessation.

Vikash Rughani: Firms need to think about the process of adhering to triReduce’s legal documentation, the data submission requirements, the consumption of output data from TriOptima or even from the CCP, and how they will adapt throughout 2021 to ensure they are maximising their compression potential as well as readying themselves for the conversion component.

As a multilateral exercise, benchmark conversion will require all-or-nothing acceptance. Participants will want to review the proposed results before providing their firm’s acceptance. Only once all parties accept the unwind proposal does it become legally binding and get processed by the CCP. This ensures all participants take responsibility for their submission, including the accuracy of their valuations and risk data to maintain the integrity of the exercise.