Hello, and welcome to another episode of the Odd Lots podcast. I'm Tracy Allaway and I'm Joe. Wisn'tal so, Joe. We are on part two of our epic library series. Yeah, I'm this is I'm very excited about this series. I'm you know, I always learn a lot from doing these podcasts with you, but this is one area that I know is a incredibly important to the way the financial system works library and the transition away from it, and also an area that I don't know nearly enough. So I'm very excited that we are moving on to part two of this year. Yeah, and just as a reminder, if you haven't listened to the first episode, you definitely should. But we basically spoke about everything that went wrong with libror, sort of pre and post financial crisis, So just as a quick reminder, there was a huge library scandal. The idea of having banks submit the reference rate for basically an unsecured loan that would be made between dealer banks was really thrown into doubt and q OR. Fast forward to where we are today and there's a huge effort underway to try to replace libraor with a brand new reference rate, right and just I mean, I assume everyone should have listened to the first episode, but just a reminder why we care in part is because so many financial contract derivative loans, etcetera. Are priced in some way off this singular reference rate. And so when it was sort of everyone realized that the old one had flaws in terms of how it was constructed, and it was open to manipulation and so forth. There is now the effort underway to get all all these contracts and debts and everything else to price around new singular stand Yeah. So in this particular episode, we're going to focus on what that new reference rate is, and we have really the perfect person to talk about it, someone who's been covering the short term dollar funding markets for years now, and I've certainly been reading his research for years. It's Joe Abote, Barclay's analyst. Joe, thanks so much for coming on the show. Thank you. How's the library transition going. How would you characterize where we actually are at this moment in time. I'd say that we're making progress. Um, you know, within the last two years, we obviously decided on what kind of benchmark replacement rate to use. I think the challenge at this point is to get people to actually use it. We're seeing developments of in futures market and term rates that reference this. We've seen people start to issue off of the rate itself. But you know this is still, relatively speaking, early days in the process. You know, we need to see volumes in particular and a number of different sectors, whether it's issuing front in terms of borrowing, whether it's in terms of hedging. We need to see that activity pick up at this point. So I'd say early days, but hopefully optimistic. So just to back up for a second, we know that after after we sort of agreed upon that Libel couldn't be sustained, what are the regulatory demands and from whom were these regulatory demands made on the financial system to find and develop a new reference rate? So um, pretty much it was a global effort, but largely it came from out of the UK where they were regulating the p r A was regulating the live AR and you know, obviously they had done the work, you know, in terms of the identifying the deficiencies in the unsecured rate, and so you know they were leading the effort. It was adopted by the fellow reserve. I think back in two thousand and fourteen and the FED effectively convened a committee called the Alternative Reference Rate Committee, which then began work to find an alternative reference rate, and then once that reference rate was decided, the Alternative Reference Rate Committee would move to kind of the adoption phase, right, so speaking to end users, if you will, to get them to start using the new rate. So it's been a you know, to your point, it's been a multi multi year process begun with regulators. So the alternative reference rate that they eventually settled on, and we spoke a little bit about this in the first episode, but it's something called the Secured Overnight Financing Rate or s o f R. So for how did they settle on that one, and what in your view is the key difference between it and the predecessor LIBOR. They essentially gave the Alternative Reference Rate Committee marching orders and told them, you know, find a replacement rate. It must be based on transparent liquid and deep market um so that you wouldn't have a submission process as is the case with live OR, and there were certain rates that you were not allowed to use basically policy instruments, right, So you could use the FED funds rate for example, and you know, after much deliberation, the Alternative Refeinary Committee settled on the SOFA. And the key difference is that I think between sofur and libor are really threefold. Right. One is that the SOFA rate is an overnight interest rate, and of course libor as a three month rate with a forward looking component. The second is that sofur is a treasury repo rate, so again it's a secured funding rate and libor is an unsecured bank borrowing rate. And then the third element of this, which is tied to that, is the fact that libor incorporates bank credit risk, which is not present in sofur. Right, So as a treasury repo rate, essentially your boring money by pledging treasury collateral, it should be especially on an overnight basis, should be risk free. So again you have a credit component a term component that are not present in the in in in so fur. So you mentioned that the the sort of benchmark rate couldn't be just a pure policy rate, So we can't just say, oh, based on Fed funds, But isn't a system that sort of de facto if it's based on the repot prices and reposing credit free treasuries, isn't it. It sounds to me like kind of a backdoor policy rate. Nonetheless, I think that's correct. I think that, you know, so FUR moves in tandem with UH with changes in the policy rate. So when the FED cuts rates, so FUR goes down, and generally speaking, it goes down by about the same amount. I think the difference is that the FEDS policy rate, the FED funds rate, is based on a fairly small market and there's only effectively one lender in that market. You know, the FED doesn't want to tie its policy to a benchmark interest rate where it's possible in the future that, let's say the FED decides that the Fed funds market is too small and wants to use a different policy instrument. If all of these a hundred trillion dollars or so in terms of live or exposure for all of that was based on FED funds, you know, moving to a different policy rate would be a much more complicated issue than just deciding on, you know, the communications strategy that the FED is going to adopt. So I agree it's kind of a back door approach, but again, so far is based st on you know, a huge volume of transactions. One final point that I want to make too, is that in an ideal world, the FED has complete control over the FED funds rate in REPO and in sofur. The FED doesn't have complete control over sofur. It can influence sofur and is very effective in doing that, but you know, sometimes sofur moves um, you know, kind of independent of FED actions. I wanted to bring up exactly this point, which is, in September of last year, we saw REPO the REBO rate shoot up, and then we saw the sofur rate basically spike along with it. And there were some people at the time who made the point that maybe you don't want a reference rate that can be that volatile UM. What's your away from that experience? My takeaway from the experience is that yes, that you know, as I was saying before, you know so for if it can influence it but can't control it, you know, on a high frequency basis day by day. I think the volatility in the overnight sofa rate is a little bit misleading, in part because the expectation is that when people you know moved to a sofa world, they're going to be using an average of daily SOFA quotes. So you're gonna be looking at you know, whether it's a three month average, one month average, You're going to be taking that as as your benchmark reference rate as opposed to the overnight interest rate. So that should take some of the volatility out of the out of the overnight rate that you know people are concerned about. But again, you have to take an overnight interest rate and convert that to a term rate like library, which means that you're doing some averaging. The question is am I doing averaging from a backward looking perspective or am I doing the averaging from a forward looking perspective? And that's a key difference between libor and SOFER right where library is you know, kind of what do I think the average bank funding rate is going to be over the three months? If I'm looking at so FUR, I'm basically saying, you know, at least at this point, what's the average overnight interest rate over the past three months? Right, And that's a little bit different than libor. Mhm h Joe. I have a quick question and then a follow up question. The quick question is what is the official deadline? Remind me for when this transition is supposed to have been complete. So the official deadline for the end of publication of libra ar is December. Okay, So the longer question I have is explained to us the complexity why is it? And I you were just talking a little bit about it in terms of the depth of this market and the challenge of converting an overnight rate into a term rate. Talk to us about the specific difficulties of you have all these contracts that are denominated in lib or, why we can't just go through all the contracts, scratch out the line lieb or replaced them with so fur and the new world is here. Yeah, I mean, I wish it were that simple. Uh turns out and I where it's not. Otherwise we wouldn't even be having this conversation. But yeah, I mean, I think, first of all, there's a technological challenge, right that in many cases there's hundreds and thousands of different instruments or references that a single bank may have that refers to library. You can take the example of of an oil company, for example, where it's not really using libor as a boring rate, it's using it as a penalty rate for people who you know, hypothetically don't make a delivery, they have to pay a charge that's equal to libor plus five hundred, and you have to go through and find all of those references, which is a monumental task. The second element of this, I think is that when you look at most financial market contracts, they have not been you know, written with fallback clauses or adequate fallback clauses for situation in which live board doesn't exist. So you know, they were kind of developed without a replacement rate in mind. And because of that there are certain things that can happen. So if you had, you know, some contracts where you know the default assumption if libralar is not available, is the floating rate on your instrument becomes whatever the last posted libel rate was, and your security becomes effectively a fixed rate security. So let's say that you've hedged yourself, or you think you've hedged yourself against interest rate risk. You're now going to have an instrument where you know the final years of its maturity, it's fixed, and that interest rate is whatever happened to be the last posted libelry rate. So if we're in a super high interest rate environment at some point and you fixed it at whatever that rate is and rates fall, you're going to be experiencing payment shock of some kind. So I think that that that's the problem. And again it's a big legal challenge to kind of go through and write these or rewrite these fallbacks. And that's just that's floating rate notes. I'm not talking about mortgages or syndicated loans and things like that, where you know, in some cases you need to have a approval of all the investors to agree to change the coupon on a security. It's a much much bigger challenge than just cutting and pasting. Are there any operational risks in the meantime during this time when we're actually making the transition from libor to sofer? For instance, a few people have been to talking about the prospect of zombie libor, which is this reference rate that is sort of dead but basically still operational and haunting the market in many ways and might not be totally reflective of what's actually going on in funding markets. Is that a risk? I think it's a potential risk, although I think that regulators are you know, realizing that that's a challenge, and so you know, the they've been kind of recommending people put in kind of what's known as pre cessation clauses, and the pre cessation clause would basically, you know, kind of trigger itself in the event that regulators deem that libor itself is not a representative interest rate. Once that happens, you know, the expectation is that publication of library would cease. To your point about the zombie situation, you might have a scenario, let's say, where you know, regulators have said the rate is no longer representative, but it's still being published. So you now have kind of a published interest rate that people can you know, legally still use, but it's been deemed unrepresentative. And that that's kind of your zombie lib or situation. You know. Zombie libor in other cases would require banks to kind of continue to contribute to the libor panel. And I struggled to see situations in which banks would willingly contribute to uh AN index when they don't have to and when there's an alternative benchmark that other people are using. So to me, I think that zombie library risk is is a low probability, but you know there's probably other operational risk that we need consider that. You know, people are working on right now, so just in terms of hitting regulatory benchmarks in demands, how realistic are they in your view in terms of making this changeover and what other kind of forbearance or moves might regulators be forced to make, you know, in the coming months ahead to deal with the question of whether we can actually UH Sunset Library as planned. You know, you could probably make the case that there should be a legislative approach that prevents you know, a litany of UM lawsuits that could follow, you know, triggering of fallbacks and the replacement of the of LIB or we might see something along those lines UM in the future right to kind of speed the process along and to kind of prevent it from getting gummed up. Banks are probably the furthest along in terms of the transition and making the necessary language and fullbacks and things like that. I think the non financial sector is probably not quite as far along in this process, and you know that might require you know, more education and urgency from ARC and regulators. I'm not sure how that gets done, to be honest. How much does UM the creation of things like um SO for futures actually help, because I think the Creme has been rolling out those contracts UM and we've actually had a few trades. Does that help with adoption? I actually think it's necessary for adoption. Right. You need to drive it as market that you can rely on for two reasons. One is to develop that term forward looking so for rate that I mentioned earlier. The second is that you need this market to be able to hedge. Right, you need to be able to know that I can convert a series of floating rate payments into fixed rate payments. If I want to go in the other direction, you need to be able to kind of to your point earlier, I want to hedge against changes in FED policy, for example, so I want to be able to use an interest rate that allows me to do that. So the ruts market is absolutely crucial for adoption of SOFA. Just remember that the your dollar market is massive compared to the size of the actual underlying trades that go into lib or. So if you think about just the size of your dollar futures, and I think it's something like two or three million UH contracts that get traded on a daily basis, you compare that to what really am ouns to about a hundred and fifty million dollars a day in double a financial cp issuance. You get to see how the derivatives market is actually far more significant, at least in terms of size, than the actual cash market. In the case of Sofur, it's the opposite. We have a much bigger cash market, right, so for volumes about a trillion dollars and you know, something like I don't know, and I'm gonna probably gonna get this wrong, but a few hundred thousand contracts are trading on a daily basis, and so for future so again, you know, I think the perspective here is the same, which is that the cash market a lot of volume futures market needs to develop in order for the for broader adoption is so fur. So just talking about the transition and potential problems is halfhearted transition a place where we could see some difficulties. So, for instance, if a company is borrowing at a libor based rate but they're getting money from a SOFER based swap, that could end up being like quite a bad mismatch. I would imagine, does that come up at all? That comes up frequently. So the issue is particularly acute for certain types of banks, who's you know, lending activity is all based off kind of libor and their funding is also off of lib or if they have to start making loans off and so for, but their funding is kind of all off of library. There's a mismatch, you know. The the big concern that people have is that, you know, you've got a lending rate that implicitly includes a bank credit component, and you know, a borrowing rate let's say that's based off of a risk free rate. What happens in an environment, let's say where there's a flight to quality and people are piling into treasuries and repo and those rates are falling, but you're borrowing is all based off of lie or, and that's moving in the other direction because bank credit risk is going up and there's no easy solution to that. To be honest, you can again rely on the derivatives market to kind of hedge some of that. But you know, the concern that people have is that there's a mismatch there. And you know the answer to this is that there will be a market that develops and picks up volume to kind of offset that rally risk if you want to call it. That. There will be a cost associated with it. My dealers are going to charge people for that. But again, it does add to the cost of transitioning to sofer. Last question, Joe, because I know you have to go, but as all these issues crop up, doesn't make you maybe more sympathetic to the library process as it was like, maybe there's a benefit to having banks come up with interest rates. Uh, you know, clearly it's embedded in the financial system as well. But maybe maybe you can make an argument even that it's countercyclical. I'm being a little bit facetious by the way I suppose you could, But to be honest, I'd much rather have an interest rate that's based on transactions UM and transparent transactions that I can look at. I struggle because you know, I can look at REPO and I think I have a decent understanding of what, you know, are the factors that move and drive repo. I have little or no transparency into bank boring rates beyond what I can see in you know, the commercial paper market, and oftentimes I'm I see movements in library of you know, in some cases a couple of basis points, and I have no explanation for that move That to me, makes it a difficult benchmark interest rate to use. If you you know, if you can't understand why it's moving on a day by day basis so far. On the other hand, I can kind of get I kind of understand why it moves up and down. I may not be able to forecast it on a daily basis with precision, but at least kind of understand what's going on in that market. There's a lot less transparency and um, you know, in the markets that are underlying Library, and I don't want to get into the all of the details, but Library is increasingly relying on Level three submissions, which basically require inputs from various different markets and different waitings attached to them. So you're getting even less transparency in the submission process as the library moves further and further closer and closer to its um it's deadline. Well, Joe, I think that's a good place to leave it. Thank you so much for coming on the show. We really appreciate it. Thank you. Thanks sure, that was great. I learned a lot. I enjoyed that conversation. I know we got a little bit um detailed in some parts of it, but I think that's the way to go, given that so much of the transition away from Library is actually all about those technicalities, like how do you the contracts which never foresaw this notion that one day we would be moving away from live horror? Yeah, exactly right. I mean I do think like in my mind this idea that's like, okay, well, libra or roughly trades in line with every other interest rate most of the time, and so for more or less trading in line with policy rates except for some occasional deviation. So why can't you just swap them? And I thought Joe did a great uh job explaining why nothing is remotely that simple when you're talking about rewriting contracts that never had this kind of one step shift in mind. Right. And the other thing that this really puts me in mind of is that zombie librar ideas. So not only do you have a shrinking pool of banks that are actually submitting their library estimates, as Joe mentioned, but you also have those estimates getting priced off level three assets, which I don't know people remember, but those are the things that are the most difficult to sort of price. So there's this notion that library is getting sort of sketchier and sketchier while the entire world is still trying to get to a place where so far, so far is the default. Right? You know what, this, this whole transition debate really reminds me of tracing. Are you gonna see a bitcoin? I'm really worried? No, no, no, no, no, no, nothing, nothing like, okay, go on, what does it remind you? Um? You know how? Like ever, once in a while, like people will we talk about some social network and like, oh, Facebook sucks. Facebook takes our privacy and our Facebook whatever. Why can't we all just switch to something new? Or Twitter sucks? Why can't we switch to say new? And it never seems to happen. And the reason is like network effects of a thing that everyone coalesced around are not There's no easy way to just sort of like red folks like I'll just jump at it, because even if if half the people jump, then then each of the new networks is not have as valuable, They're much less valuable because, for obvious reason, network effects compound. That makes sense when people are all on the same thing. So many things that we like talk about in the real world were like this sucks. Why can't we move off it? Whether it's Facebook, whether it's Twitter, whether it's the struggles that we've seen of the entire world being dependent on the US dollar or for trade. And of course this essentially all come down with this problem of it's just not so easy for us all to jump at the same time onto the new thing, even if we could clearly identify the new thing is better. See now, I thought you were going to start talking about bitcoin because of course network effects where at played there when it came to cryptocurrency adoption. Well, I guess that there's that too, but you know, no need, no need to bring bitcoin. Okay, Yes, I feel kind of bad. All right, let's leave it there before um I say anything else. This has been an other episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway and I'm Joe wi Isn't all. You could follow me on Twitter at the Stalwart, and you should follow our producer on Twitter, Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg head of podcast, Francesca Levi at francesco Today, and check out all of the Bloomberg Podcast on Twitter under the handle at podcasts. Thanks for listening.

Hello, and welcome to another episode of the Odd Lots podcast. I'm Tracy Allaway and I'm Joe. Wisn'tal so, Joe. We are on part two of our epic library series. Yeah, I'm this is I'm very excited about this series. I'm you know, I always learn a lot from doing these podcasts with you, but this is one area that I know is a incredibly important to the way the financial system works library and the transition away from it, and also an area that I don't know nearly enough. So I'm very excited that we are moving on to part two of this year. Yeah, and just as a reminder, if you haven't listened to the first episode, you definitely should. But we basically spoke about everything that went wrong with libror, sort of pre and post financial crisis, So just as a quick reminder, there was a huge library scandal. The idea of having banks submit the reference rate for basically an unsecured loan that would be made between dealer banks was really thrown into doubt and q OR. Fast forward to where we are today and there's a huge effort underway to try to replace libraor with a brand new reference rate, right and just I mean, I assume everyone should have listened to the first episode, but just a reminder why we care in part is because so many financial contract derivative loans, etcetera. Are priced in some way off this singular reference rate. And so when it was sort of everyone realized that the old one had flaws in terms of how it was constructed, and it was open to manipulation and so forth. There is now the effort underway to get all all these contracts and debts and everything else to price around new singular stand Yeah. So in this particular episode, we're going to focus on what that new reference rate is, and we have really the perfect person to talk about it, someone who's been covering the short term dollar funding markets for years now, and I've certainly been reading his research for years. It's Joe Abote, Barclay's analyst. Joe, thanks so much for coming on the show. Thank you. How's the library transition going. How would you characterize where we actually are at this moment in time. I'd say that we're making progress. Um, you know, within the last two years, we obviously decided on what kind of benchmark replacement rate to use. I think the challenge at this point is to get people to actually use it. We're seeing developments of in futures market and term rates that reference this. We've seen people start to issue off of the rate itself. But you know this is still, relatively speaking, early days in the process. You know, we need to see volumes in particular and a number of different sectors, whether it's issuing front in terms of borrowing, whether it's in terms of hedging. We need to see that activity pick up at this point. So I'd say early days, but hopefully optimistic. So just to back up for a second, we know that after after we sort of agreed upon that Libel couldn't be sustained, what are the regulatory demands and from whom were these regulatory demands made on the financial system to find and develop a new reference rate? So um, pretty much it was a global effort, but largely it came from out of the UK where they were regulating the p r A was regulating the live AR and you know, obviously they had done the work, you know, in terms of the identifying the deficiencies in the unsecured rate, and so you know they were leading the effort. It was adopted by the fellow reserve. I think back in two thousand and fourteen and the FED effectively convened a committee called the Alternative Reference Rate Committee, which then began work to find an alternative reference rate, and then once that reference rate was decided, the Alternative Reference Rate Committee would move to kind of the adoption phase, right, so speaking to end users, if you will, to get them to start using the new rate. So it's been a you know, to your point, it's been a multi multi year process begun with regulators. So the alternative reference rate that they eventually settled on, and we spoke a little bit about this in the first episode, but it's something called the Secured Overnight Financing Rate or s o f R. So for how did they settle on that one, and what in your view is the key difference between it and the predecessor LIBOR. They essentially gave the Alternative Reference Rate Committee marching orders and told them, you know, find a replacement rate. It must be based on transparent liquid and deep market um so that you wouldn't have a submission process as is the case with live OR, and there were certain rates that you were not allowed to use basically policy instruments, right, So you could use the FED funds rate for example, and you know, after much deliberation, the Alternative Refeinary Committee settled on the SOFA. And the key difference is that I think between sofur and libor are really threefold. Right. One is that the SOFA rate is an overnight interest rate, and of course libor as a three month rate with a forward looking component. The second is that sofur is a treasury repo rate, so again it's a secured funding rate and libor is an unsecured bank borrowing rate. And then the third element of this, which is tied to that, is the fact that libor incorporates bank credit risk, which is not present in sofur. Right, So as a treasury repo rate, essentially your boring money by pledging treasury collateral, it should be especially on an overnight basis, should be risk free. So again you have a credit component a term component that are not present in the in in in so fur. So you mentioned that the the sort of benchmark rate couldn't be just a pure policy rate, So we can't just say, oh, based on Fed funds, But isn't a system that sort of de facto if it's based on the repot prices and reposing credit free treasuries, isn't it. It sounds to me like kind of a backdoor policy rate. Nonetheless, I think that's correct. I think that, you know, so FUR moves in tandem with UH with changes in the policy rate. So when the FED cuts rates, so FUR goes down, and generally speaking, it goes down by about the same amount. I think the difference is that the FEDS policy rate, the FED funds rate, is based on a fairly small market and there's only effectively one lender in that market. You know, the FED doesn't want to tie its policy to a benchmark interest rate where it's possible in the future that, let's say the FED decides that the Fed funds market is too small and wants to use a different policy instrument. If all of these a hundred trillion dollars or so in terms of live or exposure for all of that was based on FED funds, you know, moving to a different policy rate would be a much more complicated issue than just deciding on, you know, the communications strategy that the FED is going to adopt. So I agree it's kind of a back door approach, but again, so far is based st on you know, a huge volume of transactions. One final point that I want to make too, is that in an ideal world, the FED has complete control over the FED funds rate in REPO and in sofur. The FED doesn't have complete control over sofur. It can influence sofur and is very effective in doing that, but you know, sometimes sofur moves um, you know, kind of independent of FED actions. I wanted to bring up exactly this point, which is, in September of last year, we saw REPO the REBO rate shoot up, and then we saw the sofur rate basically spike along with it. And there were some people at the time who made the point that maybe you don't want a reference rate that can be that volatile UM. What's your away from that experience? My takeaway from the experience is that yes, that you know, as I was saying before, you know so for if it can influence it but can't control it, you know, on a high frequency basis day by day. I think the volatility in the overnight sofa rate is a little bit misleading, in part because the expectation is that when people you know moved to a sofa world, they're going to be using an average of daily SOFA quotes. So you're gonna be looking at you know, whether it's a three month average, one month average, You're going to be taking that as as your benchmark reference rate as opposed to the overnight interest rate. So that should take some of the volatility out of the out of the overnight rate that you know people are concerned about. But again, you have to take an overnight interest rate and convert that to a term rate like library, which means that you're doing some averaging. The question is am I doing averaging from a backward looking perspective or am I doing the averaging from a forward looking perspective? And that's a key difference between libor and SOFER right where library is you know, kind of what do I think the average bank funding rate is going to be over the three months? If I'm looking at so FUR, I'm basically saying, you know, at least at this point, what's the average overnight interest rate over the past three months? Right, And that's a little bit different than libor. Mhm h Joe. I have a quick question and then a follow up question. The quick question is what is the official deadline? Remind me for when this transition is supposed to have been complete. So the official deadline for the end of publication of libra ar is December. Okay, So the longer question I have is explained to us the complexity why is it? And I you were just talking a little bit about it in terms of the depth of this market and the challenge of converting an overnight rate into a term rate. Talk to us about the specific difficulties of you have all these contracts that are denominated in lib or, why we can't just go through all the contracts, scratch out the line lieb or replaced them with so fur and the new world is here. Yeah, I mean, I wish it were that simple. Uh turns out and I where it's not. Otherwise we wouldn't even be having this conversation. But yeah, I mean, I think, first of all, there's a technological challenge, right that in many cases there's hundreds and thousands of different instruments or references that a single bank may have that refers to library. You can take the example of of an oil company, for example, where it's not really using libor as a boring rate, it's using it as a penalty rate for people who you know, hypothetically don't make a delivery, they have to pay a charge that's equal to libor plus five hundred, and you have to go through and find all of those references, which is a monumental task. The second element of this, I think is that when you look at most financial market contracts, they have not been you know, written with fallback clauses or adequate fallback clauses for situation in which live board doesn't exist. So you know, they were kind of developed without a replacement rate in mind. And because of that there are certain things that can happen. So if you had, you know, some contracts where you know the default assumption if libralar is not available, is the floating rate on your instrument becomes whatever the last posted libel rate was, and your security becomes effectively a fixed rate security. So let's say that you've hedged yourself, or you think you've hedged yourself against interest rate risk. You're now going to have an instrument where you know the final years of its maturity, it's fixed, and that interest rate is whatever happened to be the last posted libelry rate. So if we're in a super high interest rate environment at some point and you fixed it at whatever that rate is and rates fall, you're going to be experiencing payment shock of some kind. So I think that that that's the problem. And again it's a big legal challenge to kind of go through and write these or rewrite these fallbacks. And that's just that's floating rate notes. I'm not talking about mortgages or syndicated loans and things like that, where you know, in some cases you need to have a approval of all the investors to agree to change the coupon on a security. It's a much much bigger challenge than just cutting and pasting. Are there any operational risks in the meantime during this time when we're actually making the transition from libor to sofer? For instance, a few people have been to talking about the prospect of zombie libor, which is this reference rate that is sort of dead but basically still operational and haunting the market in many ways and might not be totally reflective of what's actually going on in funding markets. Is that a risk? I think it's a potential risk, although I think that regulators are you know, realizing that that's a challenge, and so you know, the they've been kind of recommending people put in kind of what's known as pre cessation clauses, and the pre cessation clause would basically, you know, kind of trigger itself in the event that regulators deem that libor itself is not a representative interest rate. Once that happens, you know, the expectation is that publication of library would cease. To your point about the zombie situation, you might have a scenario, let's say, where you know, regulators have said the rate is no longer representative, but it's still being published. So you now have kind of a published interest rate that people can you know, legally still use, but it's been deemed unrepresentative. And that that's kind of your zombie lib or situation. You know. Zombie libor in other cases would require banks to kind of continue to contribute to the libor panel. And I struggled to see situations in which banks would willingly contribute to uh AN index when they don't have to and when there's an alternative benchmark that other people are using. So to me, I think that zombie library risk is is a low probability, but you know there's probably other operational risk that we need consider that. You know, people are working on right now, so just in terms of hitting regulatory benchmarks in demands, how realistic are they in your view in terms of making this changeover and what other kind of forbearance or moves might regulators be forced to make, you know, in the coming months ahead to deal with the question of whether we can actually UH Sunset Library as planned. You know, you could probably make the case that there should be a legislative approach that prevents you know, a litany of UM lawsuits that could follow, you know, triggering of fallbacks and the replacement of the of LIB or we might see something along those lines UM in the future right to kind of speed the process along and to kind of prevent it from getting gummed up. Banks are probably the furthest along in terms of the transition and making the necessary language and fullbacks and things like that. I think the non financial sector is probably not quite as far along in this process, and you know that might require you know, more education and urgency from ARC and regulators. I'm not sure how that gets done, to be honest. How much does UM the creation of things like um SO for futures actually help, because I think the Creme has been rolling out those contracts UM and we've actually had a few trades. Does that help with adoption? I actually think it's necessary for adoption. Right. You need to drive it as market that you can rely on for two reasons. One is to develop that term forward looking so for rate that I mentioned earlier. The second is that you need this market to be able to hedge. Right, you need to be able to know that I can convert a series of floating rate payments into fixed rate payments. If I want to go in the other direction, you need to be able to kind of to your point earlier, I want to hedge against changes in FED policy, for example, so I want to be able to use an interest rate that allows me to do that. So the ruts market is absolutely crucial for adoption of SOFA. Just remember that the your dollar market is massive compared to the size of the actual underlying trades that go into lib or. So if you think about just the size of your dollar futures, and I think it's something like two or three million UH contracts that get traded on a daily basis, you compare that to what really am ouns to about a hundred and fifty million dollars a day in double a financial cp issuance. You get to see how the derivatives market is actually far more significant, at least in terms of size, than the actual cash market. In the case of Sofur, it's the opposite. We have a much bigger cash market, right, so for volumes about a trillion dollars and you know, something like I don't know, and I'm gonna probably gonna get this wrong, but a few hundred thousand contracts are trading on a daily basis, and so for future so again, you know, I think the perspective here is the same, which is that the cash market a lot of volume futures market needs to develop in order for the for broader adoption is so fur. So just talking about the transition and potential problems is halfhearted transition a place where we could see some difficulties. So, for instance, if a company is borrowing at a libor based rate but they're getting money from a SOFER based swap, that could end up being like quite a bad mismatch. I would imagine, does that come up at all? That comes up frequently. So the issue is particularly acute for certain types of banks, who's you know, lending activity is all based off kind of libor and their funding is also off of lib or if they have to start making loans off and so for, but their funding is kind of all off of library. There's a mismatch, you know. The the big concern that people have is that, you know, you've got a lending rate that implicitly includes a bank credit component, and you know, a borrowing rate let's say that's based off of a risk free rate. What happens in an environment, let's say where there's a flight to quality and people are piling into treasuries and repo and those rates are falling, but you're borrowing is all based off of lie or, and that's moving in the other direction because bank credit risk is going up and there's no easy solution to that. To be honest, you can again rely on the derivatives market to kind of hedge some of that. But you know, the concern that people have is that there's a mismatch there. And you know the answer to this is that there will be a market that develops and picks up volume to kind of offset that rally risk if you want to call it. That. There will be a cost associated with it. My dealers are going to charge people for that. But again, it does add to the cost of transitioning to sofer. Last question, Joe, because I know you have to go, but as all these issues crop up, doesn't make you maybe more sympathetic to the library process as it was like, maybe there's a benefit to having banks come up with interest rates. Uh, you know, clearly it's embedded in the financial system as well. But maybe maybe you can make an argument even that it's countercyclical. I'm being a little bit facetious by the way I suppose you could, But to be honest, I'd much rather have an interest rate that's based on transactions UM and transparent transactions that I can look at. I struggle because you know, I can look at REPO and I think I have a decent understanding of what, you know, are the factors that move and drive repo. I have little or no transparency into bank boring rates beyond what I can see in you know, the commercial paper market, and oftentimes I'm I see movements in library of you know, in some cases a couple of basis points, and I have no explanation for that move That to me, makes it a difficult benchmark interest rate to use. If you you know, if you can't understand why it's moving on a day by day basis so far. On the other hand, I can kind of get I kind of understand why it moves up and down. I may not be able to forecast it on a daily basis with precision, but at least kind of understand what's going on in that market. There's a lot less transparency and um, you know, in the markets that are underlying Library, and I don't want to get into the all of the details, but Library is increasingly relying on Level three submissions, which basically require inputs from various different markets and different waitings attached to them. So you're getting even less transparency in the submission process as the library moves further and further closer and closer to its um it's deadline. Well, Joe, I think that's a good place to leave it. Thank you so much for coming on the show. We really appreciate it. Thank you. Thanks sure, that was great. I learned a lot. I enjoyed that conversation. I know we got a little bit um detailed in some parts of it, but I think that's the way to go, given that so much of the transition away from Library is actually all about those technicalities, like how do you the contracts which never foresaw this notion that one day we would be moving away from live horror? Yeah, exactly right. I mean I do think like in my mind this idea that's like, okay, well, libra or roughly trades in line with every other interest rate most of the time, and so for more or less trading in line with policy rates except for some occasional deviation. So why can't you just swap them? And I thought Joe did a great uh job explaining why nothing is remotely that simple when you're talking about rewriting contracts that never had this kind of one step shift in mind. Right. And the other thing that this really puts me in mind of is that zombie librar ideas. So not only do you have a shrinking pool of banks that are actually submitting their library estimates, as Joe mentioned, but you also have those estimates getting priced off level three assets, which I don't know people remember, but those are the things that are the most difficult to sort of price. So there's this notion that library is getting sort of sketchier and sketchier while the entire world is still trying to get to a place where so far, so far is the default. Right? You know what, this, this whole transition debate really reminds me of tracing. Are you gonna see a bitcoin? I'm really worried? No, no, no, no, no, no, nothing, nothing like, okay, go on, what does it remind you? Um? You know how? Like ever, once in a while, like people will we talk about some social network and like, oh, Facebook sucks. Facebook takes our privacy and our Facebook whatever. Why can't we all just switch to something new? Or Twitter sucks? Why can't we switch to say new? And it never seems to happen. And the reason is like network effects of a thing that everyone coalesced around are not There's no easy way to just sort of like red folks like I'll just jump at it, because even if if half the people jump, then then each of the new networks is not have as valuable, They're much less valuable because, for obvious reason, network effects compound. That makes sense when people are all on the same thing. So many things that we like talk about in the real world were like this sucks. Why can't we move off it? Whether it's Facebook, whether it's Twitter, whether it's the struggles that we've seen of the entire world being dependent on the US dollar or for trade. And of course this essentially all come down with this problem of it's just not so easy for us all to jump at the same time onto the new thing, even if we could clearly identify the new thing is better. See now, I thought you were going to start talking about bitcoin because of course network effects where at played there when it came to cryptocurrency adoption. Well, I guess that there's that too, but you know, no need, no need to bring bitcoin. Okay, Yes, I feel kind of bad. All right, let's leave it there before um I say anything else. This has been an other episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway and I'm Joe wi Isn't all. You could follow me on Twitter at the Stalwart, and you should follow our producer on Twitter, Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg head of podcast, Francesca Levi at francesco Today, and check out all of the Bloomberg Podcast on Twitter under the handle at podcasts. Thanks for listening.