Financial Stability Board Publishes User's Guide to Overnight Risk-Free Rates
06/04/2019The Financial Stability Board has published a user's guide to overnight risk free rates, providing an overview of such rates and how they can be calculated, as well as proposals for how they can be used in cash products. The user's guide falls in line with the development of RFRs as alternative benchmarks.
The guide identifies key features of RFRs used in financial products, which include:
- Averaged rates: financial products use an average of the overnight RFR over a given period of time to smooth out day-to-day fluctuations in market rates; the average used may be either "simple" (i.e. the simple arithmetic mean of the daily RFRs) or "compound" (i.e. taking account of the fact that interest is not repaid on a daily basis and therefore applying the daily rate of interest to both the principal borrowed and any unpaid interest);
- Notification of rate: RFRs may be calculated in one of two ways: (i) in advance, meaning the rate is based on an average of overnight rates observed prior to the relevant interest period; or (ii) in arrears, meaning the rate is based on an average of overnight rates observed over the course of the interest period and only announced at the end of the period; and
- Publication timing of RFRs: where the calculation of a rate is in arrears, borrowers will only be notified of the final rate on the day that the overnight transaction is to be repaid; as a result, certain instruments (i.e. overnight index swaps, a key financial product that uses RFRs) employ a payment delay of two days.
The guide's proposals for how to use RFRs in cash products set out the different options for employing RFRs depending on whether the rate is to be calculated in arrears, in advance or using a hybrid method.
View the FSB User's Guide.
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