BEST PRACTICES GUIDE

BNY Mellon Data and Analytics Solutions

Instrument Engineering Team

Last Update: 07 Aug 2020

TABLE OF CONTENTS

OVERVIEW

This document applies to all releases of Eagle software V15 R2.39, V17, and above. Version-dependent functionality is noted with the initial release(s) it became available.

Please include Instrument Engineering (DA_InvestHelp@bnymellon.com) on all inquiries about alternative reference rate (ARR) indexes.

Market

For many years, Interbank Offered Rates (IBORs) were the gold standard when it came to trading securities linked to floating rates. London Interbank Offered Rate (LIBOR) was the most well-known, but it's various sister indexes in other countries (CDOR, JIBAR, etc.) were also widely used. Securities linked to these IBORs included floating rate bonds, syndicated loans, interest rate swaps, total return swaps, and numerous other derivatives. One downside of these indexes is their susceptibility to manipulation by a relatively small group of bad actors, which can have wide-ranging effects on markets.

As a result, most issuers and counterparties of standardized floating rate securities are abandoning LIBOR and its sister indexes in favor of new alternative reference rate (ARR) indexes. These include the Secured Overnight Financing Rate (SOFR) for the US, Euro Short-Term Rate (€STR) for the EU, and Sterling Overnight Index Average (SONIA) for the UK, among others. Securities linked to this indexes also include daily resets and rate compounding to ensure the latest ARR is always used for accruals.

ARRs may also be referred to as risk-free rates (RFRs) in the market. This acronym was introduced by the Financial Stability Board in their July 2014 publication on benchmark interest rate reform. The phrases "near risk-free rates," "risk-free rates," and "alternative reference rates" are generally accepted as interchangeable and should be defined as reference rates that are being developed by international central bank-led working groups as alternatives to LIBOR.

Eagle

Accounting can accrue on securities linked to ARR indexes using the core fixed income code in V15 R2.39, V17, and above. We have identified three different accrual conventions.

1. Simple Average Interest: rates are retrieved directly from an ARR index, with no compounding at the index level
   • Bloomberg Calc Type = 21(FLOAT RATE NOTE) or 1421(FLOAT RATE NOTE)
   • Applies to FHLB bonds
   • Fully supported
2. Spread Inclusive: rates are retrieved from an ARR index and the spread is added before calculating Compound Average interest
   • Applies to Overnight Index Swaps (OIS) as detailed in the 2006 ISDA Definitions
   • Fully supported
3. Spread Exclusive: rates are retrieved from an ARR index and Compound Average interest is calculated, while the spread is accrued using simple interest and then added
   • Bloomberg Calc Type = 999(STREET CONVENTION)
   • Applies certain US corporate bonds, such as those issued by Goldman Sachs and Morgan Stanley, and a wide range of other bonds issued in Europe, the UK, and other countries
   • Fully supported (V17 2.20 & V15 R2.39); miscellaneous income or expense transactions can be used to true up differences in earlier versions

An example of the spread-exclusive calculation is shown below.

Existing Securities

Two methods are available to support existing securities that will be transitioned to ARR indexes, as explained in the 882147773 section.

Workaround

If you are using a version of Eagle Accounting that does not have core support for ARR accruals, you can achieve a close approximation by using an alternate security setup. This is described further in the 882147773 section.

REFERENCE DATA

Storage & Configuration

Securities linked to ARR indexes that use compound average interest have a unique setup in Eagle that uses a multi-level underlying relationship. This does not apply to Simple Average interest securities, such as FHLB bonds, that retrieve and use rates directly from a published index. Instead of the index holding the published rates ("published index") being linked directly to the security, a secondary "calculation index" is linked to the security, with the published index as its underlying. This is how it looks:

• ARR Security with Compound Average Interest (bond or leg of a swap)
  • Calculation Index (USD-SOFR-COMPOUND, GBP-SONIA-COMPOUND, etc.)
    • Published Index

The published index should be set up exactly like LIBOR or any other floating rate index.

The calculation index needs a few extra fields populated, as described below.

• Final Rate Rounding Precision (2283): 0.001%, 0.0001%, or 0.00001%; specifies rounding precision for compounded rate of return
  • Note: these values are not stored directly in Data Management; instead, they are translated to 5, 6, and 7 respectively and stored using tag 12402 of the same name
    • If you are using Message Center to set up a calculation index, you must include 12402 = 5, 6, or 7 in your message, and 2283 can be left out
• Final Rate Rounding Direction (12403): Down, Nearest, or Up; specifies the direction of rounding for fractional numbers based on Final Rate Rounding Precision
• Project Rate (12404): typically No or NULL
  • Selecting Yes will cause Accounting to project an overnight compounded rate through the end of the coupon period, which may be required in some cases

Once both indexes have been created, link them using Add Underlying Security. Populate the fields as described below.

• Asset ID (14) & Type (1432): a cross reference identifier for the calculation index
  • These are not stored in the UNDERLYING_SECURITY table; instead, they are used to look up the Security Alias (10) of the parent security, which is stored in UNDERLYING_SECURITY.SECURITY_ALIAS
• Underlying Asset ID (1348) & Type (1103): a cross reference identifier for the published index (USD-SOFR-COMPOUND, GBP-SONIA-COMPOUND, etc.)
  • These are not stored in the UNDERLYING_SECURITY table; instead, they are used to look up the Security Alias of the underlying security, which is stored in UNDERLYING_SECURITY.UNDERLYING_SEC_ALIAS
• Underlying Type (916) = OIS (Overnight Indexed Swap)
  • This is critical to ensuring ARR accruals are calculated correctly

Once the underlying indexes are configured, set the calculation index as the underlying of the bond or swap leg during security setup using the underlying security fields:

• Underlying Security ID (1348): Primary Asset ID of the calculation index
• Underlying Security Issue Name (1141): Issue Name of the calculation index

Market Data

Published Index: load ARRs received from vendors just as you would for LIBOR or any other floating rate index.

Calculation Index: do not load any rates to this index as it is used for calculation purposes only.

Security Data

Most security master file (SMF) data is configured the same way as any other floating rate security. Please note these important considerations and exceptions.

• Make sure to set Underlying Security ID and Underlying Security Issue Name to the calculation index, not the published index
  • This only applies to securities using Compound Average interest; Simple Average interest securities, such as FHLB bonds, should be linked directly to the published index
• First Rate Reset Date (10911) = Dated Date (1183) + 1
• Reset Frequency (1788) = 1_D (Daily)
• Reset Lookback Days (10547): # of days prior to each reset date, or Dated Date (1183) for the initial period, to grab the new floating rate; typically 0, 1, or 2
  • This should be confirmed for each security as it is not consistent across securities linked to a particular ARR index
• Reset Lookback Days Type (5075): typically C (Calendar) for floating rate notes or B (Business) for OIS
  • This is based on Instrument Engineering's observations to date; please confirm the correct value with your reference data vendor
• Fixing Date Business Center (16407) must be populated even though it is not marked as required
• Security-level compounding should not be used
  • Leave Compounding (11875) blank on the SMF or set it to No in all cases because Compound Average compounding is done at the index level in Eagle Accounting
• For spread-exclusive securities, set Compounding Method (11876) = SE (Spread Exclusive)
  • Do not populate any other security-level compounding field
  • This should be the only difference from a spread-inclusive security
• Lockout Days (10549, V17 R2.21): defines the length of the lockout period (1, 2, 3, etc.), if applicable
• Lockout Period (18083, V17 R2.21): defines the period(s) to which the lockout applies; A (All) or L (Last)

Workaround

Use the configurations below for versions of Eagle Accounting that do not have core support for ARR accruals. Because this is only an approximation, you will have to use Miscellaneous Income and Miscellaneous Expense transactions to true up to the correct cash flows on coupon dates.

TRADE PROCESSING

Once the reference data is set up, traded interest will be calculated correctly based on the daily compounded rates.

ACCOUNTING

Once an ARR security trade is booked it will be picked up in Eagle’s global workflow. Daily accruals and periodic resets are generated as part of the earnings process. This can be scheduled or triggered manually.

• V17 & Above: Accounting Center > Processing and Exceptions > Global Processes > Earnings > Run Income Accruals
• Prior to V17: Global Process Center > Earnings > Accrue

The attached OIS_Calculation_Example.xlsx contains an example SMF and calculations.

CHANGE INDEX

Three methods are available to support existing securities that will be transitioned to ARR indexes. All methods assume the transition occurs on a coupon date.

1. Update Existing SMF
   1. Add new underlying security (and spread, if applicable) directly to the existing SMF
      1. Make updates before accruals have been triggered for Earn Thru Date = date of transition, but after accruals have completed for the previous date
   2. Once the SMF has been updated, any accruals triggered subsequently will use the new accrual terms
      1. Note: this applies to all dates (backdated activity that results in rollback/replay will use the new accrual terms, even if some dates should use the original terms)
2. Create New SMF, Redenomination of Bonds
   1. Create a new SMF with the updated accrual terms
      1. See Reusing Cross Reference Identifiers
   2. Create and process a Redenomination of Bonds corporate action to move the position
      1. Set Ex Date (65) = date of the transition and Conversion Factor (1716) = 1.00
      2. Note: this maintains the lot-level data for multi-lot positions
3. Create New SMF, Close and Open
   1. Create a new SMF with the updated accrual terms
      1. See Reusing Cross Reference Identifiers
   2. Book a close and an open to move the position
      1. Close the existing position at cost and allow Eagle Accounting to calculate traded interest (should be zero)
      2. Open a position in the new security at the same cost and allow Eagle Accounting to calculate traded interest (should be zero again)
      3. Note: to maintain the lot-level data, you will have to book a separate close and open for each lot

The first method is easiest to implement, but does not ensure the integrity of past accruals. The second method ensures the integrity past accruals and maintains an audit trail between the closes and opens by using a single event, but requires new SMFs. The third method also ensures the integrity of past accruals and may be easier to automate depending on your trading/order management system (OMS), but requires new SMFs and and also involves dummy trading activity. You should select whichever method fits best with your business requirements and operational resources.