Predictive Analytics — LIBOR Case Study

Last week, our blog observed that predictive analytics does not always require AI. Sometimes, a simple calendar with an alerting function can help strategists and analysts appear clairvoyant when really all they are doing is connecting the dots faster. Consider the GlobalMacro calendar we have created in our open Slack channel:

When an analyst or strategist sees this array of meetings concentrated in a 7-day period, no AI is needed. A reasonably well-informed human will know that the global publicly policy debate would shift towards financial stability and market liquidity risks. Indeed: market liquidity references and action from the official sector were visibly increasing every day last week, with the highest readings on February 20:

It does not take a rocket scientist to realize that when action levels are high regarding market liquidity issues…without a financial crisis…interesting structural shifts are underway within technical policy. When the distribution of the activity includes the CFTC, the ESRB, ESMA and the ECB, it’s time to dig into the details.

The interesting part is to see HOW the policy spikes are occurring. On February 20, the first item that popped up was this hyper-technical action from the European Central Bank regarding the shift away from LIBOR to locally-based benchmarks for pricing financial contracts.

The language of the statement is as important (and alarming) as the issuance of a statement itself. The report text is more problematic:

Financial market participants in the working group are allied with the central bank for the world’s second largest reserve currency begging market participants to stop pricing their contracts using LIBOR. Even though no one, including the experts, knows how pricing curves and overnight rates will evolve operate in the wild, open markets once they are in use. While the overnight rate issue is acute in Europe, other comparable challenges exist in the United States, Japan, and other global reserve currencies simultaneously creating localized pricing benchmarks to replace LIBOR.

Presto. Predictive analytics. The full scope of strategically significant market liquidity risks for the next three years are now on display.

Scenario analysis designers need to be modeling right now a range of technical issues regarding risk pricing, operational risks associated with financial contract re-pricings, re-negotiations, and possible litigation, as well as related regulatory capital risks, bank liquidity challenges….especially if in parallel after Brexit the European Systemic Risk Board decides to reject AT1 and Tier 2 instruments currently recognized as regulatory capital because those instruments do not recognize the authority of the SRB to mark down the contracts in a resolution situation.

So noone should have been surprised yesterday when the Bank of England used a speech at an industry conference to urge market participants to accelerate their adoption of alternative pricing benchmarks.

Regarding the resolution risk issue in Europe, please see our blog post from earlier this week HERE, written just after the European Systemic Risk Board released proposed rules for how to treat AT1 and T2 capital instruments in “third countries” (ie., the UK and the US, among others). The main point is that two significant shifts will occur simultaneously in 2021: the LIBOR transition and Brexit.

You don’t need a crystal ball to prepare strategically for predictable public policy inflection points; you just need a calendar and the ability to track technical policy moves on a daily basis.

For more information on how the platform can accelerate your ability to identify strategically significant developments please contact us. If you would like to join our free and open Slack channels, we will be glad to send you an invitation if you reach out to us.

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