Since the 1980s, Interbank Rates (IBORs) have been the primary reference rates for the calculation of interest payments on cash and derivative products.
Globally, regulators are now encouraging a shift away from IBORs to Alternative Reference Rates (ARRs) for the following reasons:
- IBOR rates are intended to represent the amount large banks charge each other for unsecured loans, but are often based on scarce underlying transaction data and/or traders’ judgment
- Several scandals have revealed the ease with which IBOR rates were subject to manipulation in the past
Unlike IBORs, ARRs are overnight rates. This implies that ARR products may use backward daily averaging to calculate interest payments. Forms of averaging can be simple averaging or daily compounding and may also use ARR-specific conventions.
In addition, when it comes to forecasting and discounting, term forward-looking IBOR rates will need to be replaced by forecasting an overnight rate or, alternatively, by building an ARR term curve from which forward rates can be generated.
Moody’s Analytics is supporting this transition. The following is a summary of relevant capabilities in our RiskConfidence platform.
Product Level: Backward Daily Averaging1, covering:
Rate Level: Alternative Reference Rate Handling, which includes:
- Input of historical rates
- Input of overnight forecast index
- Input of term yield curve
- Generation of forward overnight rates from an inputted term yield curve
- Discounting and valuation using term yield curve5
1) newly launched means from version 7.1.5 onwards
2) constant installment amortizing loans included from 7.1.5 onwards
3) backward daily compounding formula was aligned with ISDA methodology from v7.1.5 onwards. Conventions referenceable in FTP formula from v7.1.7.
4) available for LOANDEPO table from v5.2 & REPO table from v6.2; available for ACCOUNT/FACILITY/SECURITY/SWAP from 7.1.7.
5) pricing of Swaptions and Cancellable Swaps using ARRs is a further planned enhancement in 2021