RFR adoption Q3 2024
===

Ali Curi: Hi everyone and welcome to ION Markets Quick Takes. I'm Ali Curi and every week along with my guests Chris Barnes and Mark Bell, we take a quick dive into the headlines on the Clarus blog. 

Let's get started. Hi Chris. Hi Mark. 

Chris Barnes: Hey Ali. How are you doing? 

Mark Bell: Hey Ali. 

Ali Curi: I'm doing well. Chris, let's start with you. What's your Quick Take for this week? Which headline from the Clarus FT blog would you like to discuss? 

Chris Barnes: All right, quick take 60, 70, 30. That's it. That's the end of the podcast. All you need to know for today's podcast, literally a Quick Take 60, 70, 30. Now we could continue our game of Quick Takes Bingo from last week.

And guess what I'm talking about? The title on the blog is "RFR Adoption Q3 2024." So in a nutshell, what I'm talking about are three numbers, all looking at what percentage of the market is trading against a "Risk Free Rate" and what percentage of the market is trading against so called "Legacy Rates."

This all stems out from work that Clarus have been doing with ISDA for years and years and years. We now only do a quarterly update, and I think I'd like to take the opportunity on the podcast to talk a little bit more about what these numbers really mean. 

So first off, 60 percent. 60 percent is the percentage of the global market that now trades against RFRs. 70 percent, that's the amount of the dollar market that trades versus SOFR and 30 percent is the amount of the euro market that trades versus €STR. Now, I'd like to address not so much the elephant in the room, but the kind of why are we still talking about RFRs, right? And I think you have to bear in mind that this project, yes, it started from a regulatory angle. Everyone knew that LIBOR was going to cease eventually. What would that transition path be? LIBOR's now ceased, and yet we're still continuing to talk about these numbers. Why? Very, very simple. This is an interesting insight into a piece of market structure that we've never really had before. And we've never been able to track it reliably.

And it is fundamentally interesting for market participants to think about what structures, what area of the market people are actively choosing to trade in. And I think even if this is the first time you've ever seen these numbers, or if it's the hundredth time, it still remains an interesting, let's say, "anchor" for people's perception of markets.

Number one, 60 percent of global trading takes place against RFRs. That's been the case for like a year now. We haven't had any meaningful changes in the regulations of the underlying currencies, and that headline number is astoundingly stable. I'm not great at pulling numbers out of thin air. Let's say it's range somewhere in a 5 percent range between 58 and 66.

If you want to see the precise data, if you want to see the graphs, have a look at the chart. That is very stable, irrespective of what happens with Trump election, irrespective of what happens with worries in markets in August and carry trades, irrespective of what happens with perception of Fed policy, that number's been really stable.

And I think if you're new to markets, that's a really important takeaway. Market infrastructure fundamentally is really stable. When you're sat in front of screens, all the numbers are moving all the time. You're trying to make sense of what feels like chaos. Trader's job, a lot of it is to see through that and to see the stability and to see the ability to move risk through markets in a very professional way. And having this level of transparency allows people to get comfortable with what the market infrastructure is. Second point though, is that there are changes, right? And so for example, in dollars, we've seen the percentage of SOFR trading drop from as high as 80 percent down to mid 60s now.

That is definitely a change. Is it a change that will be sustained? Is it a change as a result of differences in opinion in what Fed Funds shows versus what SOFR shows? Is it a difference between activity at the short end versus long end? There's lots of questions and lots of angles on the data that you can pick out as a result of just these very high level numbers.

What I would suggest for Q3 is that it was as a result, a direct result, of a lot of short end trading. So there was more trading done in things like fed funds futures than we saw in the previous quarter. And you don't necessarily know that just from sitting in front of your screens. It does take a bit of a reflective pause at times.

And to say, look, we have got access to this data. Let's use it. Let's use it mindfully. And let's look at whether there are any trends. I think that's another thing I would add to points one, two, and three. I would add a fourth. There aren't a lot of trends here. This is really something that's difficult to get a handle on. It's not something that's intuitive. I don't write these blogs with an expectation of what the numbers will show. And so it does take that time, effort, and engagement with the data as well to work out exactly what is happening. One of my nice charts there shows in swaps markets, the amount of risk that's traded at Fed Funds has changed from 7 percent to 25 percent in like four months.

I think actual market participants who are trading this would be able to tell us more about that, whether that's as a result of more basis trading. There's been an article just this week about changes potentially in Fed Funds versus SOFR. And so it's really nice to see the data reflected that.

Very, very quickly, finally, euros. Euros, we're writing a lot on in the €STR space at the moment anyway, because it's really interesting from a market share perspective. In light of three futures exchanges having a battle for €STR market share. September 2024 saw 34 percent of all euro risk traded versus €STR. September 2023 saw 34 percent of all risk traded against €STR, but that has been far from constant between those two data prints.

So I've tried to pull out some of the interesting facets behind it. Mark, do you have any specific questions that you want to fire my way? 

Mark Bell: Thanks, Chris. So 60, 70, 30 certainly makes for an easy understanding of where we are with RFR adoption, but maybe let's just sort of dig a little bit more into the euro one with 30 percent being in €STR and the rest in the Euribor market.

There's been a push recently from pension funds and asset managers in Europe to transition from discounting cash flows with Euribor, to discount cash flows with €STR, how should they assess when to make this type of change in discount curve and how would the change in discount curve impact the 30 percent share that €STR has at the moment?

Chris Barnes: I love this question, right? This is exactly what we're talking about in terms of the data. There's the potential for a shift in the market. There's a potential for a shift in market behavior. Do we see it in the data? Should market participants be using the data to inform their choices? A hundred percent, hell yeah, you should be using our data to inform your choices.

You don't want to go and switch all of your liabilities to €STR discounting average maturity of 20 or 30 years if there's no €STR trading. That's why transparency in the markets is so, so important for these big structural shifts. Most market participants, this is our experience speaking, want to be a close follower. They want to look, they want to act. They want to be a good corporate citizen. They want to maintain good relationships with both dealers and regulators and clients. They want to be making the right choices at the right time. What that means is it normally takes a first mover who goes, "Yes, this is a little bit risky, but it's the right thing to do."

And so even before you start looking at the data, there also is a cultural question there. Are you going to be the leader in this move or are you going to be a close follower? Everybody wants to be that close follower, but it will take one to take that first big leap. And as we go to publication date, I don't know who that first leader will be, but I do think that it will happen sooner rather than later.

Mark Bell: And then a second, maybe more technical question, we see from our ISDA some clients that firms doing bilateral margin are still building €STR curves as a spread to the Euribor curve. When in the transition can we expect to see these curves built from €STR-only quotes? 

Chris Barnes: You should be doing it now, honestly, running spread curves. You want to go to the lowest common denominator, the simplest curve. €STR is the simplest curve. You have far fewer idiosyncrasies in your building of an overnight rates curve. In my opinion, I will not say in my humble opinion, cause I'm pretty sure I'm right with this. And so I would say you really want to switch it now.

The data is reliable. It's a mature market. It's ready to go. You should be switching now. 

Ali, I think that's all we've got time for. I'd just like to say a big thank you to Mark, they were excellent questions this week. 

Mark Bell: Thanks, Chris. 

Ali Curi: Thank you, Chris. And please tell us again the title of your blog post.

Chris Barnes: I guess I should claim that it's 60, 70, 30. But I will use those numbers for the next one. This time "RFR Adoption Q3 2024." 

Ali Curi: Great. That works. Chris Barnes, Mark Bell. Thank you both for sharing your Quick Takes. Let's do it again next week. 

Chris Barnes: Looking forward to it, Ali. See you next week. 

Mark Bell: Thanks, Ali. 

Ali Curi: And that's our episode for today. You can read more about these topics on the Clarus blog, and you can follow ION Markets on X and on LinkedIn. 

Thank you for joining us.