Thursday, May 29, 2008

Alternatives to Libor gain ground

(Financial News Online) Swaps traders are reporting record interest in alternatives to Libor, in the first indication that the market may start to shift away from the international benchmark that has dominated the capital markets for more than two decades.

The alternatives, the overnight interbank average rates known as Sonia for sterling and Eonia for euros, represent the weighted average of actual deposit rates reported by banks.

Libor and Euribor are instead calculated each day as the average of what contributing banks think their own funding costs are. Libor and Euribor are three-month rates and Sonia and Eonia are overnight rates.

Swaps are pegged against the overnight fixings are known as Overnight Indexed Swaps, or OIS. The OIS market is a small sub-segment of the interest rate swaps market that has traditionally concentrated on short maturities of under two years.

Frits Vogel, head of swaps at interdealer broker Icap, said he had seen a marked increase in OIS in the past few weeks.

He said: "The vast majority of business is still fixed against Libor but there has been a big push from some of the major firms to foster liquidity in OIS across the curve. There is market demand for two rate curves,”one against Libor and another against the overnight fixings."

Gilles Saiagh, head of short-term derivatives at money and interest rate brokerage HPC in Paris, said: "Customers increasingly want to see liquidity in long-term OIS and if the dealers are going to be aggressive quoting these prices, they need to create a proper liquid market."

However, traders said although interest levels are high, volumes to date remained small.

Christophe Coutte, head of swap, cash, inflation and emerging rates trading at Societe Generale, said: "The most developed is Eonia on the long end, where we have received more requests than usual, and typically around maturities that we didn't used to see in the market. We had a price of 10-year/30-year spread Eonia in the market and I can't recall the last time I saw this."

Goldman Sachs hosted an investor day on OIS markets for clients earlier this month and other banks, including Barclays Capital, Societe Generale and BNP Paribas confirm growing interest in the overnight fixings.

Icap is preparing to publish indicative OIS prices on screen and Barclays Capital is to introduce executable prices in OIS out to 50 years on its Barx electronic trading platform, which will increase the visibility of these products in the market.

Interest in the alternative overnight fixings has grown on the back of doubts over Libor, the lack of three-month unsecured funding and because of the dramatic widening in the spreads between the two types of fixings.

Nat Tyce, head of sterling and Scandinavian rates trading at Barclays Capital, said the OIS market has grown faster than the Libor market in the past two years for a particular type of trade, where hedge funds and bank proprietary traders used the benchmarks to gain exposure to expected outcomes of central bank meetings.

He said: “Since July last year we have seen interest explode as the difference between OIS, reflecting central bank policy expectations, and Libor/Euribor, which reflect bank funding costs, has become apparent to everyone.

"So we are seeing interest from cash, forward FX traders, hedge funds, real money accounts, mortgage lenders, asset swap traders and even some corporates."

Traders said they saw OIS as a complementary product to Libor interest rate swaps, rather than replacing it.

A spokeswoman for the British Bankers Association said: "We have seen no interest from our members to establish another benchmark other than Libor. One of the strengths of Libor is that it is subjected to rigorous and open scrutiny, which gives it an edge over any of the potential ratings. Libor is, and will remain the benchmark for fixing of currencies in the spot and forward market."

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