Reuters: Regulatory News: Strong start for GCF but market skeptical on Libor-replacement

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Strong start for GCF but market skeptical on Libor-replacement Jul 19th 2012, 18:39 By Mike Kentz Thu Jul 19, 2012 2:39pm EDT NEW YORK, July 19 (IFR) - The rates-trading market stood on alert this week to see how US Treasury futures launched on Monday by NYSE on the DTCC General Collateral Finance Repo Index would perform, and the volumes did not disappoint. But the chatter surrounding the GCF as a possible replacement for Libor as the primary benchmark for asset pricing appears to be headed for a number of significant obstacles. The Libor-fixing scandal has prompted market participants to re-think the benchmark used for valuing an estimated US$350trn of swaps and US$10trn of loans. Speaking before the US Congress last week, Federal Reserve Chairman Ben Bernanke agreed Libor was flawed and discussed alternatives for a worldwide rates benchmark. "The Federal Reserve has not come out in favor of a specific one, but a number of possibilities include repo rates, the so-called OIS index and even potentially Treasury bill rates, for example," Bernanke said. GCF has been touted as a potential candidate, but traders said the industry needs a robust market for over-the-counter swaps on the index before it can supplant the Fed Funds Effective rate, much less Libor, as one of the primary benchmarks. In order to do that, participants highlighted the need for a set of standardised trading and confirmation practices, a project currently being undertaken by a working group through the Securities Industry and Financial Markets Association. A leading member of the working group told IFR the group has come to "significant agreements around most of the practices" and that "firms are going through their internal practices to determine how they're going to participate and when they're going to participate." The member could not explain any of the agreements nor provide an estimated completion date, but said the group was in the "nuance stage" of the process, and had been working together for "months". A liquid futures market is expected to augment the OTC market, said Paul Scurfield, head of short rates trading for the Americas at Bank of America Merrill Lynch in New York, and last week's volumes were encouraging with 6,446 contracts changing hands on Wednesday. "Prior to the inception of the GCF future we had minimal transactions in the OTC market for general collateral because the underlying hedge is an on-balance sheet risk," said Scurfield. "The capital costs, liquidity and brokerage costs have been significant for an OTC swap." "The futures volumes have been strong but the index would need an accompanying basis swap market and delta-one general collateral index-linked swaps before it could replace any of the established benchmarks, and that would have to come after the futures market development. This will likely not happen before 2013," he added. Additionally, the GCF is based on short-term repurchase agreements, meaning some traders are concerned the valuations would not reflect lending rates further out the curve. "The GCF is more like a bridge between the Fed Funds Effective rate and Libor," said a senior rates trader based in New York. "It's less technical than Fed Funds and has more volume, which means it's more accurate and reliable, but I'm not convinced you could develop a market for longer term swaps on it." There were signs on Wednesday the futures contracts could attract liquidity in longer-dated tenors, though, with some contracts with over a year in maturity changing hands. Link this Share this Digg this Email Reprints

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