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    ECB Group Recommends Voluntary Compensation for Legacy Swaptions

    June 16, 2020

    ECB announced the recommendation of the private-sector working group on euro risk-free rates that counterparties should voluntarily exchange compensation for legacy swaption contracts. These legacy contracts are those affected by the transition of central counterparty discounting from the euro overnight index average (EONIA) to the euro short-term rate (€STR), which is planned for around July 27, 2020. The working group notes that this recommendation is based on feedback received from the March 2020 consultation on swaptions impacted by the central clearing counterparties (CCPs) discounting transition to the €STR.

    The working group emphasizes that any agreement between counterparties to make adjustments to their contracts or exchange compensation, whether based on the working group recommendation or not, would be entirely voluntary.  The working group recommends that market participants contact their swaptions counterparties to determine whether they intend to consider voluntary compensation. Prompt action is recommended to avoid an extended period of uncertainty, minimize any valuation difference, and promote responsible risk management and market liquidity and resilience. The working group acknowledged that the modalities for implementing voluntary compensation may vary, as already outlined in the public consultation on swaptions impacted by the CCP discounting transition to the €STR. Market feedback collected during this consultation did not point to one single preferred modality for implementing voluntary compensation, which means a working group recommendation could not be established for such implementation modalities. Thus, the working group decided not to recommend one approach above others, as market feedback did not single out a preferred option. Consequently, the working group is sharing additional information on what appears to be the most feasible and preferred options with market participants to assist them in making their own decisions. 

    Additionally, in feedback to the March consultation, no consensus emerged on the scope of the swaption contracts to be compensated and on the timing of the voluntarily exchange. Half of the respondents were in favor of the working group recommending that voluntary compensation exchange take place at a pre‐agreed date prior to the CCP discounting switch date, with compensation exchange for each swaption at expiry as a backstop. Based on the feedback provided in the consultation, and in the absence of a consensus on one date, the following key dates could determine the relevant swaption contract population:

    • Date on which this recommendation is published (June 16, 2020)
    • Go‐live date of (ISDA Supplement 64 to the 2006 ISDA Definitions published on March 30, 2020    
    • Date on which the CCPs announced the discounting switch date (from September 2019 to January 2020 for each CCP respectively)
    • CCP discounting switch date (July 27, 2020)

     

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    Keywords: Europe, EU, Banking, Securities, Legacy Swaptions, Swaptions, Risk Free Rates, €STR, EONIA, CCPs, Benchmark Reforms, ISDA, ECB

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