Case Study |

LIBOR Transition, Obtaining Permission to Trade Alternative Rate Swaps

  • Context

  • Got permission for the fixed income desk to trade fixed/float swaps where the floating leg uses an Alternative Rate (AR; overnight tenor). Most vanilla fixed/float swaps use LIBOR as an index yet LIBOR for the major currencies (CHF/EUR/GBP/JPY/USD) will cease to be published after 12/31/2021.   The desk needs to be able to trade swaps where the floating leg pays tenor rates (e.g., 1M, 3M, 6M) based on an AR.

The Project

– Documentation was updated to define ARs for each of the major currencies.  For the most developed AR (SOFR; to replace USD LIBOR), tenor methodology (backward compounding of daily rates) was described, and published rates by the FRBNY were referenced.  A list of legacy overnight rates was provided.   Methodology for extracting a SOFR curve was given.

– For the non-major currencies, e.g. AUD and CAD, a list replaced an earlier accounting simply of currencies with maximum maturities.

– Because the desk has a live SOFR – Effective Federal Funds Rate (EFFR) deal, it was used an example.  The text was augmented to show pricing steps for such a basis swap.   Formerly, the text had just showed fixed/float swap steps;  testing referred to a synthetic basis swap. Discounting was generalized to include the case of ARs (e.g., SOFR, ESTR for EUR) instead of legacy rates (resp. EFFR, EONIA).

– An additional testing section vetted the model on the live deal.  The compounding was replicated.  The underlying SOFR and EFFR forwards were closely replicated, except at month ends where rates are known to be volatile.   Published tenor rates were matched.


The model enhancement allows the desk to trade SOFR swaps analogous to ordinary USD LIBOR fixed/float swaps up to 15 months maturity, above which the SOFR curve is not well defined by exchange-traded instruments.

Although the live SOFR/EFFR deal studied uses different discounting on each leg, convergence to purely SOFR discounting  (in October 2020) was shown to have minimal impact.

The desk will be able to price SONIA (replacement for GBP LIBOR) and SARON (CHF LIBOR) swaps when tenor rates (published, and replicated in this exercise) using the proposed methodologies are published by regulators.   ESTR and TONAR (JPY) tenor rates are under development.

Bloomberg capabilities, including the ability to search for live AR deals and the EONC<go> screen for computing tenor rates, were exhibited to the client.   A meeting convened at the client’s site with Bloomberg personnel evinced the need to strip out the LIBOR language of 3,000+ deals in order to determine impact of the LIBOR transition.