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𝗧𝗵𝗲 𝗜𝗻𝘃𝗲𝗿𝘁𝗲𝗱 𝗣𝘆𝗿𝗮𝗺𝗶𝗱 𝗣𝗿𝗼𝗯𝗹𝗲𝗺 𝗶𝗻 𝗘𝗨𝗥𝗜𝗕𝗢𝗥: 𝗛𝗶𝗴𝗵 𝗹𝗲𝘃𝗲𝗿𝗮𝗴𝗲 𝗮𝗻𝗱 𝗵𝗶𝗴𝗵 𝘀𝘁𝗮𝗸𝗲𝘀 One critical issue for EURIBOR is what can be described as the "inverted pyramid". For every euro in underlying transaction of EURIBOR, there exists over €2.000 of derivatives volume referencing EURIBOR. And this figure takes into account only derivatives traded via LCH. It shows a tremendous leverage effect where the real economy is dwarfed by financial instruments tied to these rates. Looking at the graphic below, we can see that the monthly transactions underlying EURIBOR are on average slightly less than 7 bn EUR per month over the last two years (level 1 and 2.2 contributions from the waterfall methodology). Considering the minimum transaction size of 10 million and assuming 20 working days per month, this means that there are on average 35 transactions per day. 𝗪𝗶𝘁𝗵 𝗰𝘂𝗿𝗿𝗲𝗻𝘁𝗹𝘆 𝟭𝟵 𝗽𝗮𝗻𝗲𝗹 𝗯𝗮𝗻𝗸𝘀, 𝘁𝗵𝗮𝘁 𝗶𝘀 𝗻𝗼𝘁 𝗲𝘃𝗲𝗻 𝟮 𝘁𝗿𝗮𝗻𝘀𝗮𝗰𝘁𝗶𝗼𝗻𝘀 𝗽𝗲𝗿 𝗱𝗮𝘆 𝗽𝗲𝗿 𝗽𝗮𝗻𝗲𝗹 𝗯𝗮𝗻𝗸! This vanishingly small number of transactions in recent years has left EURIBOR susceptible to manipulation. Individuals or entities with large positions in derivatives could potentially influence EURIBOR movements significantly, given the substantial incentives involved. Given the small number of daily transactions, influencing just a few could have a disproportionate impact. However, the EURIBOR reform marks an improvement. Going forward, a considerable portion of EURIBOR will be derived from €STR, resting on more concrete, real overnight transaction data. Therefore, this linkage to €STR not only reduces the potential for manipulation by eliminating EURIBOR’s ‘expert judgement’ but also by diluting the impact of any single transaction, 𝗺𝗮𝗸𝗶𝗻𝗴 𝗘𝗨𝗥𝗜𝗕𝗢𝗥 𝗮 𝗺𝗼𝗿𝗲 𝗿𝗼𝗯𝘂𝘀𝘁 𝗮𝗻𝗱 𝗿𝗲𝘀𝗶𝗹𝗶𝗲𝗻𝘁 𝗯𝗲𝗻𝗰𝗵𝗺𝗮𝗿𝗸. For more insights and continued updates, feel free to contact me or my colleagues at LPA. Let's delve deeper into how these crucial changes are reshaping the landscape of financial benchmarks 🚀

EM FX sensitivity & asymmetric risk reward to Renminbi The original model was built at the peak of the COVID year, and it is time to revisit individual EM FX’s sensitivity and asymmetric risk-reward under extreme Renminbi (CNH) moves. Framework: The analysis was based on the most recent 13Y daily data. I use a VaR shock technique to distinguish extreme CNH moves (rally & sell-off). The 1Yr scenario reflects the most recent market sentiment and dynamics; however, it is more volatile and could be skewed by individual EM FX’s idiosyncrasy. When looking at the sensitivity to CNH, in addition to Beta, we also need to consider the correlation. The Asymmetric Risk Return is the average return during the extreme periods. Takeaways: 1. Contrary to the geographic proximity to China, Asian FX has the lowest sensitivity to CNH, and EUR & CEE4 have the highest sensitivity. This reflects the strong linkage between Germany & China’s trades. 2. EUR & CEE4 provide the best risk reward asymmetries, followed by high credit quality Asia currencies. LatAm probably provides the worst risk-reward. 3.  CZK, EUR, RON, HUF & PLN provide the best risk-reward in the long run, TWD, KRW, INR, IDR are least sensitive to CNH large moves, with a flat risk-reward. 4.  COP, CLP, BRL, TRY*, & ZAR are highly sensitive to CNH with the worst risk-rewards. (TRY is less correlated & has significant idiosyncrasy in recent years). ZAR is the one that particularly stands out, as it exhibits its strong systemic risk nature to the macro environment, to some extent, BRL & CLP too. 5.  Positive CNH Shock: ZAR, HUF, CZK, PLN are extremely sensitive. 6.  Negative CNH Shock: ZAR, BRL, CLP, COP are extremely sensitive. Post-COVID: 7.  The EM FX has become less sensitive to the CNH movements now (Pic 5), post China reopening fatigue? This is in-line with what we observed in other risk assets – becoming less sensitive to the China news. The recent “de-risk” and “dual circulation” themes? (Pic 4 Table 1) 8.  In the long run the market is more reactive to the CNH sell-off than to CNH rally. However, as recently (1Y), the market is more sensitive to China’s positive news than to its negative news, and the average asymmetric payoffs become less negative compared to the long-term trend. 9.  During the COVID period, 1Yr and 2Yr ago, the story was very different and the EM FX was more sensitive to China compared to the long run average. Did the Fed hiking take away China’s spotlight? 10. Interesting to note, compared to pre-COVID (1Yrx4Yr ago vs 1Yr), Asia as a region has become less sensitive to China and its risk reward is positive. LatAm significantly reduced its sensitivity to China but its risk-reward didn’t change and is still negative. EMEA is the only one that increased its sensitivity but risk-reward has turned from positive to negative. It’s worth considering this under the context of the looming EV spats. #china #emergingmarkets #fx #asia, #macroeconomics, #markets, #fixedincome

« GlobalTrade Finance », a prestigious multinational conglomerate, operates across diverse geographical locations and consequently, encounters multifaceted currency exposures. Adept currency risk management isn't just advisable—it's imperative for maintaining the company's robust financial health. As a Senior Currency Strategist at GlobalTrade Finance, you're responsible for devising and executing foreign exchange (FX) hedging strategies. One of your mandates this quarter is to optimize hedging mechanisms for the EUR/USD currency pair, considering the potential turbulence in the forex market. Question 1: GlobalTrade Finance anticipates that the Euro will strengthen against the US Dollar over the next six months. Which of the following describes a typical risk reversal strategy you might employ? a) Buy a EUR call / USD put option and sell a EUR put / USD call option. b) Buy a EUR put / USD call option and sell a EUR call / USD put option. c) Sell a EUR call / USD put option and buy a EUR put / USD call option. d) None of the above. Question 2: Which of the following statements about the risk reversal strategy is FALSE? a) It helps to hedge against unfavorable movements in the FX rate. b) It provides the company the opportunity to benefit from favorable movements in the FX rate. c) It entirely eliminates the company's exposure to currency risk. d) It involves the simultaneous purchase and sale of out-of-the-money options. Question 3: Assuming the company does not want to incur any upfront premium, which structure should the risk reversal be set at? a) At-the-money. b) Deep out-of-the-money. c) Zero cost. d) In-the-money. Question 4: What is the primary risk associated with implementing a risk reversal strategy as opposed to a straightforward FX forward contract? a) Credit Risk b) Counterparty Risk c) Opportunity Cost d) Liquidity Risk Post completion of the quiz, compile your answers and submit them to the Director of FX Risk Management. Your insights and understanding of the strategy will be instrumental in determining the next steps for our currency hedging initiatives. #GlobalTradeFinance #CurrencyRiskManagement #EURUSDHedging #RiskReversalStrategy #FXOptimization #ForexMarketDynamics #HedgingExpertise #StrategicFXManagement

One approach to #stresstesting the amount of #capital required by a bank for #creditrisk is to use parameterised account level models with credit application characteristics, behavioural characteristics and macroeconomic factors as predictors. Viani Djeundje Biatat and Jonathan Crook propose a new #methodology for estimating a more #accurate estimate of the amount of capital required. More articles on the use of #operationsresearch for #creditrisk can be found here: https://lnkd.in/egcMBt-V

More than 80% of derivatives market participants expect FX derivatives clearing to increase in the coming months, according to a report published by Coalition Greenwich (a division of CRISIL), fueled by a renewed focus on the efficient use of capital, balance sheet, credit, margin and collateral. Cleared over-the-counter FX volumes have increased 42% in LCH’s ForexClear in the past 24 months, while cleared notional is up 25%, according to Coalition Greenwich. Refinitiv, an LSEG business Natasha Rega-Jones https://lnkd.in/eYiB6JHe

Over recent decades, there has been a notable reliance on credit instruments, which significantly expanded the global financial system. However, current tensions between East and West, along with concerns about debt saturation and inflation, are eroding this trust. Consequently, the equilibrium between financial instruments involving counterparty risk, such as credit, and those devoid of counterparty risk, like gold, is poised to undergo an adjustment, favoring the price of gold. Got Gold? https://lnkd.in/gcva9ub6

ICMA have released the latest semi-annual survey of the European Repiarket. The total size of the survey grew 11.5% year-on-year to a record EUR 10,794 billion, continuing the uptrend launched in 2016 by the ECB’s Enhanced Asset Purchase Programme (EAPP) and the market’s assimilation of post-GFC Basel regulations on capital, leverage and liquidity.   The growth of the survey was driven by the flow of new cash into repo, attracted by higher interest rates and steeper yield curves in the money market and the protection given by repo against credit and liquidity risk. However, there are signs of survey growth decelerating.

ICMA’s European Repo and Collateral Council (ERCC) has today released the results of its 45th semi-annual survey of the European repo market, showing a new record outstanding value of EUR 10,794 billion at June 2023. The survey measured and analysed the value of outstanding repo plus reverse repo on the books of 62 participants at close of business on 14 June 2023, excluding monetary policy repos with central banks, and it was not adjusted for double-counting. Given that the ICMA surveys a sample of the European repo market, the headline number must be taken as the minimum size of the European market. The ICMA survey is about 50% of the size of the size of market given by UK and EU SFTR public data. The total size of the survey grew 11.5% year-on-year to a record EUR 10,794 billion, continuing the uptrend launched in 2016 by the ECB’s Enhanced Asset Purchase Programme (EAPP) and the market’s assimilation of post-GFC Basel regulations on capital, leverage and liquidity.   The growth of the survey was driven by the flow of new cash into repo, attracted by higher interest rates and steeper yield curves in the money market and the protection given by repo against credit and liquidity risk. However, there are signs of survey growth decelerating. Summary of key findings: - In net terms, the survey sample cut back its long-standing cash lending/securities borrowing position, reflecting the QT-driven shift away from the trading of specific and special collateral. - Floating-rate repo continued to gain share in the rising interest rate environment. - Tri-party repo rallied on the back of the recovery in GC repo (of which it is a sub-set). The share of voice-brokers also rallied.  - Despite a strong inflow of government bonds, their share in the pool of European collateral fell as the use of non-government securities rose at a faster rate, in particular for covered bonds that could formerly be financed on the ECB’s TLTRO facility.  - The share of French government bonds used as collateral overtook that of German government bonds as benign market conditions dampened demand for what has been the preferred safe asset for investors.  - The unwinding of ECB support forced peripheral eurozone banks back into the repo market, boosting use of Italian and Spanish collateral.  - The share of sterling repo contracted, possibly reflecting a shrinking short base as economic and monetary conditions in the UK stabilised.  - There was a seasonal contraction in term-to-maturity and forwards fell back but remain significant.  - The survey sample ran an even more negative funding gap, that is, borrowing short-term and lending long-term. https://lnkd.in/eZsNQz3V

📊 Kyriba’s latest Currency Impact Report reveals a staggering $29.14 billion impact on multinational earnings due to currency volatility in Q2 2023. European companies face an unprecedented 349% increase in headwinds compared to the previous quarter. 💡 Melissa Di Donato, Chair and CEO of Kyriba, highlights the urgent need for global organizations with significant overseas exposure to adopt robust FX risk management strategies. In these times of intense economic volatility, CEOs and CFOs must prioritize data-driven approaches to safeguard their companies’ value against currency fluctuations. 👉 Read the full press release to learn more: https://bit.ly/49JuX3q #RiskManagement #FX #CurrencyVolatility