Normal fixings expire without any flow

Ordinarily, the risk on term fixed derivatives expires without any flow on the fixing date of the contract. This means that large exposures to the fixing can lead to opportunities to profit if the fixing process involves smaller notional trading volumes in the fixing process (cf. the inverted pyramid problem with LIBOR).

FAIRFix fixing risk of sellside are replaced

FairFix derivatives mandate that the risk exposure (of the sellside institution) be replaced by a non-competitive order (to pay or receive a regular OIS swap) at the auction. This order is in the opposing direction to that which would assist a potential manipulator and so sterilises any manipulation attempts.

.

Sellside have no exposure to FAIRFix

Market makers replace their FAIRFix fixings with overnight fixings and so have no net exposure to FAIRFix. With no exposure, there is no way for them to profit from moving the FAIRFix fixing rate higher or lower.

Supply and demand determines the price

FAIRFix is the only fixing methodology that removes conflicts of interest, prevents manipulation and is based on transactions ensuring that genuine supply and demand conditions determine level of fixing rates.

Example A

• Speculator pays Bank A in £20bil 3m FAIRFix SONIA fixing on 15 November.

• On 15 November, Speculator pays Bank B for £5bil 3m SONIA OIS to try and manipulate the FAIRFix fixing rate higher.

• Bank A submits £20bil non-competitive offer to receive FAIRFix fixing (to neutralise their paying FAIRFix exposure on the FAIRFix derivative).

• Bank B submits £5bil competitive bid which still leaves £15bil non-competitive offer in search of competitive bids.

• This £15bil offer tends to push rates lower (not higher), sterilising any manipulation attempts.

• This sterilising effect is not present in any other fixing methodologies.

Example B

• Speculator pays Bank A in £20bil 3m FAIRFix SONIA fixing on 16 November.

• On 16 November, Bank A submits £20bil non-competitive offer to receive FAIRFix fixing (to neutralise their paying FAIRFix exposure on the FAIRFix derivative).

• Speculator submits £20bil non-competitive bid at FAIRFix auction to negate the order they know Bank A will be submitting.

• The net flow from these orders is zero but so too is the exposure of Speculator to FAIRFix now. The fixing rate might well fix higher but this will reflect that Speculator has paid on £20bil of regular OIS SONIA trade and so this is entirely justified by supply and demand conditions.

• Speculator ends up with a genuine risk seeking trade in 3 month SONIA OIS and has not manipulated the FAIRFix rate (to which they have zero net exposure).

Example C

• Speculator pays Bank A in £20bil 3m FAIRFix SONIA fixing on 17 November.

• On 16 November, Bank A submits £20bil non-competitive offer to receive FAIRFix fixing (to neutralise their paying FAIRFix exposure on the FAIRFix derivative).

• Speculator submits £25bil non-competitive bid at FAIRFix auction to negate the order they know Bank A will be submitting.

• The auction will now have a net paying interest of £5bil in the non-competitive side of the auction which will tend to push the rate higher. This will also be Speculator’s net exposure to FAIRFix. However they will now need the fixing rate lower, not higher, to profit from this. And they will also have a £25bil paid position in 3m SOINA OIS which is a genuine risk seeking trade.

Negative feedback loop

The zero net exposure condition (for market makers) and the derivative obligation create the perfect negative feedback loop which ensures that FAIRFix rates cannot be manipulated. This is because market makers have no net risk to the fixing and can only move the rate higher by paying a higher rate (or lower by receiving a lower rate) for the entirety of the volume in the auction… And because the FAIRFix fixing risk of banks is replaced by the identical risk in a regular OIS deal, effecting the sterilisation of any manipulation attempts.