LIBOR Transition Learning Goals – Topics in Focus
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Risk Management
Learning Objectives
- Impact of LIBOR/RFR transition on risk management.
- Working through model validation – simulations, quantitative changes and documentation.
- Conducting simulations and quantitative impact analysis, e.g. recallbration of historical parameters, for P&L, MTM and limits.
- Impact on derivative and cash versus instruments, e.g. swaps vs. bonds.
- Managing risk limit modifications, e.g. LIBOR vs. SOFR DV01.
- Addressing hedge breaks, e.g. cash/derivatives, impact of convention difference.
- Management of non-quantitative risks – operational, regulatory reporting, etc.
- Management of LIBOR transition timelines, e.g. across currency exposures across U.S. and Europe/other jurisdictions.
- Preparing for regulatory interactions – documentation of changes and inspections.
- Addressing changes in internal and external reports, e.g. LIBOR being replaced by several RFRs + credit.
Course Framework
1. Risk Management for Fixed Income Instruments
- Fixed income limit and risk control framework
- Overview of specific risk parameters and greeks
- Risk control and management workflow
- Limit violations and mitigation
2. LIBOR Transition Impact on Financial and Non-Financial Principal Risks
- Identification of risks introduced with LIBOR replacement RFRs
- RFR replacement data sources and management
- Impact on models and recallbration
- Process and documentation risks
3. Incorporating Replacement RFRs/Fallback Characteristics and Behavior
- Components of RFR curve documentation
- Case Study of RFR documentation – zero curves
- Interpolation techniques and choice
- Market data and curve reallingment
4. Impact on Existing Model Libraries
- Fixed Income models and methodologies
- Derivatives models and methodologies
- Modifying and adjusting for RFR replacement differences
- Managing model risk management workflow
5. Risk management workflow and impact of LIBOR replacement
- Identification of incremental risks
- Model bencharking
- Case Study of RFR impacts
- Alignment and explanation of MTM differences
6. Fallback Language and Waterfall
- ARRC Recommended Fallback Language for Securitization
- ARRC Recommendations on Fallbacks for Adjustable-rate Mortgages (ARMs)
- ARRC Recommended Fallback Trigger Language for new issue FRNs
- European Central Bank (ECB) Guidance on Fallbacks for Euro Rates
7. P&L Impact on Fallback Date and Its Implications
- Significance of value transfer for existing Libor contracts
- Impact on counterparty exposure, collateral and xVA measures
- Impact of tax treatment on the decision- making process for transition timing
- Limits and risk mitigation on potential fallback P&L impact
- Exposure measures and hedging of LIBOR SOFR basis spread
8. Redocumentation Risk, Broken Hedges and Hedge Cashflow Mismatches
- Management of timing differences when assets, liabilities convert to LIBOR
- Impact of client vs Street swap payment conventions on hedge slippage
- Analysis of impact of observation period shifts on projected vs realized cashflows
- Ability to achieve exact hedge between loans and swaps
- Basis risk for illiquid callable SOFR swaps
- Decomposition of a LIBOR swaps into OIS and SOFR swaps
9. Impact on Interest Rate Option Products
- New cap/floor conventions to hedge student loans
- Fannie and Freddie options demands for caps
- Current option products traded for RFR
- Difference of Eurodollar convexity adjustment from SOFR futures
- Impact of CCP discounting switch on bi-lateral Swaptions
- Impact of fallback on swaptions and caps and floors
- Introduction to extending LIBOR market model to backward-looking rates
10. LIBOR Market Model Introduction and FMM
- Difference of Transition Impact on Hull&White and LMM
- Review of LMM and it’s Underlying Behavior
- Issues with LMM and Reset in Arrears Backward Looking Rates
- Model Changes based on Lyashenko and Mercurio
- Deterministic Volatility Decay Function and Ease of Implementation
11. LIBOR Transition Impact on Curves, Option Models, Cashflows and Accruals
- New Instruments and New Forward Rate Behavior
- Updated Accrual and Payment Conventions
- Required Modifications to Forward Rate Convexity Adjustments
- Mismatch Patterns due to Business Days Weightings and Quarter/Year End Spikes
- Temporary Need for Volatility Proxies due to Lack of Liquidity
- Implied Volatility Intra-Period adjustments and Decays
12. Vanilla/Static, Dynamic and Credit Models
- Term Structure Models for Interest Rates
- Market-Implied PD and LGD Models
- Actuarial-Statistical PD, Risk Migration and Loss Models
- Stochastic Models for Equity,FX and Commodity
13. Hands-on New Payment and Accrual Conventions for FRN and Swaps for Reconciliations
- Differences among 1M SOFR, 3M SOFR, Eurodollar and Fed Fund future
- Reasons for calculation differences
- Differences of payment and accrual conventions among fixed income, lending and derivatives
- Listing of reliable rate calculation engines for reconciliation of payments
- Detailed examples of payment gap, lockout, observation shift and observation period shift
- Reset in Advance SOFR option products
14. Build the Short End of the RFR Curve and Cross-Currency Basis
- Instruments to define LIBOR, RFR, OIS curves and their relationships
- Interest rate parity for FX forwards and if RFR will have an impact on FX projections
- Impact of RFR on the cross-currency basis in the short end of the curve
- Implementation of the short end of the curve and implied likelihood of Fed Fund rate
- changes
- Multiple different overlapping futures contracts in a single curve
- SOFR term rate and futures
15. Build the Long End of the RFR Curve and Cross-Currency Basis
- Many alternatives to build the long end of the curve
- Removal of LIBOR dependency on the SOFR curve
- Long end discussion with SOFR outright vs basis to OIS or LIBOR
- Necessity for multi-curve bootstrapping when SOFR swap discounts on SOFR
16. Deriving Volatilities for A Proxy Index
- Generalized dynamic model of Mercurio
- Deriving SOFR volatilities from LIBOR volatilities
- Numerical examples of shifted lognormal
- Numerical examples of SABR replication
17. Impact of small SOFR convention discrepancies to discount factors
- Curve dependency examples and how it affects errors in zero rates
- Pricing examples for swaps and it’s curves and reconciliation impact
- Payment and accrual convention impact on zero rates
- Pricing examples for swaps and it’s curves and reconciliation impact
18. Smooth Interpolation with Various Interpolation Techniques
- Desirable features of any interpolation techniques
- Quite comprehensive view of interpolation techniques
- Different interpolation methodologies on zero, forward rates and discounting factors
- Can linear methods have continuity in forward rates?
- Spline methods and mentioning of Hermite interpolation as well as Hagan’s monotone convex method
19. Pitfalls of Flat Daily One Day Forward Rates and FOMC Meeting Dates
- Implied jumps in forwards due to FOMC meeting and future expiration dates
- Curve generation algorithm in detail combining overlapping futures
- Can you build a good forward rate curve with bootstrapping or do you need an optimization across instruments
- Large spikes in forwards close to FOMC meeting dates
20. Consent Solicitation
- Diversity of Consent Solicitation based on Asset Class
- Consent Solicitation for English Law Legacy Bond Contracts
- Operationalizing consent solicitation
- New York State legislative measures
21. Fannie Mae and Freddie Mac LIBOR Transition Playbook
- Single family ARMS and securities
- Single family credit risk transfer
- Collateralized mortgage obligations
- Multifamily ARMS.MBS, FRNs and credit risk transfer
22. Principles of Quantitative Model Validation and Model Risk Management
- Definitions of Model, Model Risk and Input/Output/Engine components
- Model Uses across the Enterprise using Practical and Closed Form Calculations
- Required Processes for Model Validation for Fundamental Changes or Rates
- Apply Quant Culture with IT Discipline to Manage Transition
23. Model Users and their Expectations
- Behavior and Expectations of Traders and Business Decision Makers
- Risk Management across Enterprise and Desk level
- Financial Controls and Accounting
- Regulators and Policymakers and Expectations on Transition
24. New Model Risk Contributing Factors
- Econometric Model Changes for the the new Risk-Free Rates
- Backward and Forward Looking Term Rates and Shift of Effective Dates and Accrual Dates
- FAS133 Hedge Effectiveness Testing Changes for new Benchmarks and Transition
- Statistical Behavior of the new Rates and Credit Components
- Model Risk Contributing Factors and Changes in Market Regime
- New or Untested Model Type or Class
25. LIBOR Usage and Major Components of Required Model Changes
- Compounding, Averaging and Daily Observation Impact
- Curve and Collateral Dependency Revision across all Currencies
- Move from HJM/LMM to FMM Model
- Convex Accrual Function across all Asset Classes
- Funding and Loan Index Recommendations to Account for Credit Component of LIBOR
- Timeseries Considerations and Historical SOFR model to have data back to 1998
26. Dynamic Mortgage Models with Current Coupon, Prepayment and Credit
- Stochastic Interest Rate Models and CMS Rates as Inputs
- Current Coupon Model and lack of SOFR History
- Prepayment, Default, Loss Severity Models
- Structured Securities and Collateral LIBOR assumptions
27. Regulatory Reporting and Guidance on Model Risk Management
- Risk policies and governance
- Analysis and internal reporting
- Impact on model risk management framework
- Alignment of internal and regulatory reporting