Risk Managing the LIBOR Transition

15 Pages Posted: 27 Feb 2021 Last revised: 7 May 2021

See all articles by Claudio Albanese

Claudio Albanese

Global Valuation

Stefano Iabichino

JP Morgan

Paolo Mammola

Citigroup Global Markets Limited

Date Written: December 11, 2020

Abstract

By halting the LIBOR's publication, large volumes of fixed income securities, from loans to derivatives, will fall back to an alternative fixing reference. The initial proposal of a SOFR fallback eliminated any degree of subjectivity but opened up funding risk. Overlaying a credit spread over SOFR is a remedy that goes in the right direction, but neither guarantees a robust hedge for funding risk nor prevents accidental wealth transfers.

To ensure robust funding risk hedges under all scenarios, we propose to complement the fallback rate by overlaying it with periodic exchanges of Funding Valuation Adjustment (FVA) reset amounts. Our proposal accomplishes the LIBOR indexing’s mandate of transferring banks’ funding risk to counterparties more accurately and robustly than the LIBOR itself while being objective and legally robust.

We conclude that the LIBOR transition is an excellent stimulus and opportunity to improve funding strategies and, if implemented with foresight, can make the financial system more resilient and efficient.

Keywords: LIBOR, FVA, risk management, funding risk

JEL Classification: G18, G15, G24, E43

Suggested Citation

Albanese, Claudio and Iabichino, Stefano and Mammola, Paolo, Risk Managing the LIBOR Transition (December 11, 2020). Available at SSRN: https://ssrn.com/abstract=3746939 or http://dx.doi.org/10.2139/ssrn.3746939

Claudio Albanese (Contact Author)

Global Valuation ( email )

9 Devonshire Sq.
London, London EC2M 4YF
United Kingdom

Stefano Iabichino

JP Morgan ( email )

London
United Kingdom

Paolo Mammola

Citigroup Global Markets Limited ( email )

Citigroup Centre
Canada Square
London, E14 5LB
United Kingdom

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