OIS Swaps

Axel van Nederveen Treasurer, EBRD Moscow, November 2010

Outline

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OIS Swaps

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OIS (RUONIA) vs. LIBOR (MOSPRIME) swaps

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Advantages of OIS Swaps

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Further steps in market development

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OIS Swap

Interest Rate Swap with overnight index used for float leg Replicates the exposure of a short-term loan funded by an overnight deposit or an overnight loan funded by a short-term deposit Overnight index used is (usually, not always) calculated by Central Bank as weighted average of rates on overnight trades on a given day (RUB: RUONIA, EUR: EONIA, USD: Fed Funds, PLN: POLONIA…) Swaps are predominantly short term (<1y)

OIS Swaps

Cashflow diagram

Fixed Leg Cashflow: Z% x Notional x Days x Day Count Pay Fixed Leg: Z% Receive Float Leg: OIS Daily O/N Fixings Floating Leg Cashflow: Daily compounding of O/N rates (annualised) x Notional x Days x Day Count

OIS Swaps vs. LIBOR Swaps

OIS LIBOR

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  “ Pure” interest rate risk: credit and liquidity risk negligible in overnight trades Reliable floating leg fixing

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 Generally a short term (<1Y) market   

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  Long term swaps are currently based on LIBOR Float leg a better match to floating rate assets and liabilities Post-crisis, large liquidity premia priced into LIBOR These are now bank-specific, so LIBOR is no longer generic Doubts over credibility of LIBOR fixings

Post-crisis developments in derivatives markets

Post-crisis developments in derivatives markets

Moreover, the problem is expected to persist: 10y 3M Euribor vs 6M Euribor basis swap 2004-2010

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Post-crisis developments in derivatives markets

Liquidity and credit risk premia have become embedded in LIBOR whereas OIS is a cleaner measure of interest rate expectations The unsecured term interbank money market is not coming back.

Banks have started using OIS-based instead of LIBOR-based discount curves for derivative valuations.

Valuation have become dual curve based rather than single curve based.

Advantages of OIS Swaps

  Market Participants Allows hedging of short-term exposures to a real traded rate Provides opportunities to express views about direction of interest rates   Monetary Authority Transparent measure of market interest rate expectations Central Bank of Russia to target RUONIA, as ECB/Fed (normally) do?

Further steps in OIS Market Development

  Overcoming the current limitations of OIS swaps – Lengthening the tenor of swaps on offer – Making float leg of OIS a better match to risk profile of floating rate assets and liabilities Keeping it simple: make OIS swaps look more like LIBOR swaps, while retaining their beneficial features – For swaps longer than 1 year, replace the overnight fixing on the floating leg with a short-term OIS swap fixing (e.g. 3 months) – A “swap-within-a-swap”!

Thank you!

Q&A

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