December 2024
While the world obsesses with Generative AI, some quietly make our financial system hum along. Before July 2023, the US credit market participants had several options for credit-sensitive rates: BSBY, Ameribor, and AXI (and its companion FXI). Today, only AXI remains. It has a better design than the other now-extinct alternatives. AXI also stands out because its creators sought an independent assessment of the IOSCO Principles 6, 7, and 9 for Financial Benchmarks. In an unusual move in July 2023, the international standard setter IOSCO declared that BSBY and Ameribor did not satisfy these three principles.
Do not expect a regulatory endorsement, but the silent non-objection suggests financial institutions in the US can embrace AXI. The volume of contracts referencing AXI will scale up rapidly. Derivative markets are sure to follow, reinforcing the primary markets.
Substantial work awaits financial institutions: This metric needs to be in bank data "arsenal," as a credit risk driver. Financial institutions need new models for forecasting and simulating the credit spread. Financial institutions must build valuation models for the assets tied to the new index. As models must be validated before they can be used, the modeling effort must begin in earnest. Not least importantly, researching the AXI properties will help get business lines on board sooner rather than later.
Finally, once shifting to a new index, financial systems could optimize their credit risk management: from better data quality to new early warning indicators. At the very least, one could build a more performant system allowing at-will scenario analyses.
Read a version that our team helped write on SOFR Academy Insights or IBM Promontory Blog.
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