The key to FAIRFix was recognising that the desire of end users to use a term fixing is analogous to a willingness on their part to submit a non-competitive order to the auction… in both cases, the end user is passively submitting to the use of a prevailing market rate in their interest rate contracts. The beauty of FAIRFix was solving how to translate the interests of end users into non-competitive orders at the auction.

In the first instance, FAIRFix term fixings will be derived from the mid market prices of competitive bids and offers submitted by FAIRFix market makers. These fixings will then be suitable for use as a benchmark for cash and derivative contracts. Loans referencing FAIRFix are likely to be amongst the first products that use the fixings, enabling banks and other lending institutions to start offering all customers an easily implemented change in benchmarks from the old IBOR rates onto the new ARR rates.

These FAIRFix referencing ARR loans will generate a term fixed asset, for the lending institutions, of either 1, 3, 6 or 12 month duration, every time the loan rate is re-fixed. However, Bank treasuries manage all their cash flows on an overnight basis and so they will have a term fixed asset being funded by an overnight fixed liability. And this is where FAIRFix, unlike all other fixing methodologies, will prove to be superior. On the day that they have a FAIRFix loan fixing, these treasury desks can submit a non-competitive bid to pay that day’s FAIRFix auction transacted rate on an OIS swap that matches the duration of their FAIRFix loan fixing. And as that rate is defined to be equal to the FAIRFix fixing rate, this action will swap their term fixed asset into an overnight fixed asset, thus enabling them to match off the tenors of their assets and liabilities.

This non-competitive bid will enter the auction, and after netting off against any non-competitive offers, will result in a net balance of non-competitive orders to pay or receive, that then transacts at the auction clearing rate, determined by genuine supply and demand conditions.

And in the same way that floating rate loans will now be able to transition simply from IBOR rates to ARR rates, Floating Rate Notes (FRNs) will also be able to transition to term fixed ARR rates. This will give both investors/issuers the ability to choose whether to have either term fixed assets/liabilities or overnight fixed assets/liabilities whilst using the FAIRFix fixing rate for FRNs. This freedom to choose whether to be benchmarked against the overnight rate of the term fixing rate ensures that the one rate is suitable for all participants and ensures that all liquidity congregates to FAIRFix further enhancing liquidity in the underlying ARRs. In addition, unlike for the current complicated and disparate realised overnight rate accruals that are being trialled for ARR benchmarked FRNs, the overnight benchmarking that you achieve (by swapping your FAIRFix fixings into the overnight fixings) is on the exact same overnight accrual basis as actual cash overnight transactions and, more importantly, as the regular OIS swap (realised rate) accruals.

Wherever there are cash instruments that reference an interest rate benchmark, there will always be a need to swap these exposures in derivative markets. Unlike for other term fixing solutions for ARRs, FAIRFix fixings are suitable for use in all derivative products.

FAIRFix fixings have a unique condition on their use in derivatives that results in further non-competitive orders at the auction. This condition is a contractual obligation on one party to any derivative contract to submit (where possible) their resultant FAIRFix fixing exposures to the relevant FAIRFix auction. This unique feature is the “magic potion” that makes the FAIRFix methodology work and once there are derivatives that reference FAIRFix, there will be mandated non-competitive orders in the auction. This will further encourage FAIRFix market makers to supply liquidity on the competitive side of the auction.