If USD-LIBOR could speak he would probably use the famous quote:
The news of my death is greatly exaggerated.
With six week into the new year that was supposed to be "no new USD-LIBOR", the situation appears to evolve very little. LIBOR is not the undisputed king of USD interest rate benchmark anymore, but is still largely present. SOFR, that was presented as the new king, fails to justify that reputation.
SOFR volumes is increasing, both in absolute and relative terms. The increase is undisputed, but it has not manage to overtake the two incumbents, LIBOR and EFFR, yet. Figure 1 represents the share of the different products cleared at LCH on a weekly basis since the start of 2022. Some SOFR increase is clearly visible, from 15% on week 1 to 19% on week 6, some LIBOR decrease from 42% to 31%, and the maybe unexpected EFFR increase from 40% to 45%. SOFR is still only bronze medalist in this 3-way competition. Moreover the LIBOR volume does not look like a pure "risk reduction" play. The outstanding amounts of USD-IRS at LCH has increased by 2,270 bn this week after a 1,695 bn increase last week.
Figure 1: Market shares for the different benchmarks at LCH in 2022
In absolute term, on a longer term horizon, there is a clear increase in SOFR volume as presented in Figure 2. In the last 6 months, the volume has increased from roughly 500 bn a week to 3,000 bn a week. Certainly a significant increase, but far from what was promised or expected by the "SOFR First" phases launched in the last 6 months.
Figure 2: SOFR volume in the last 9 months
If one looks at the ISDA figures (available here), representing the transactions disclosed under US regulation, the impression is the same: an increase of SOFR use, but still well below LIBOR.
The figures mentioned above are in term of notional. One could also look at the share in term of risk or DV01. This is what the Clarus RFR Adoption Indicator does. The increase is SOFR is visible also, but there also SOFR is far from being dominant. For January 2022, its share is 28.5%.
Some articles indicates that SOFR is taking over LIBOR in voume terms, in particular this Bloomberg article: SOFR liquidity eclipses LIBOR. It is based on trading activity on Bloomberg; it reports a 73% market share for SOFR. It would be interesting to understand why this subset of market activity favors SOFR why the general market does not.
The article provides also some very interesting information about bid-offer spreads. It says that (on Bloomberg platforms) the bid-offer for SOFR swaps is almost as narrow as spread for LIBOR swaps for 5, 10 and 30 years tenors. Our surprise is in the "almost". A 30-year LIBOR swap will be converted in less than 18 months into a SOFR swaps, using a not fully specified mechanisms and an still uncertain date. The fact that the LIBOR swap, which is an indirect SOFR swap with extra operational features (and risks), is trading at a narrower bid-offer than the original SOFR swap does not look to us as a positive sign for the market.
Nevertheless there is potentially an explanation for the narrower LIBOR bid/offer that still take into account the fact that LIBOR post-June 2023 is a transformed SOFR. Suppose that SOFR is the base market and that the LIBOR rates are simply computed from the SOFR curve using the ISDA fixed spread. Actually there is no "simply computed" mechanism, but a "model-dependent-and-subjectively-computed" mechanism as discussed before (see for example here or in our paper "ICE Swap Rate fallback: impact on swaption pricing"). We could have a situation where all market makers have SOFR swaps bid/offer narrower than LIBOR swaps but with different models to convert from SOFR to LIBOR rates, resulting in a market-wide bid/offer which is narrower for LIBOR. The model volatility will compress the wider individual bid/offers for LIBOR into a collective narrower bid/offer.
Plenty of quant work to understand all those issues.
On a related subject, IBA is launching its ICE Term SOFR rate in beta version. The existence of those Term rates are providing mechanism closer to the one provided by LIBOR with periodic term fixing and not overnight fixing. The market is slowly developing the tools to go back to LIBOR-like products, at least in operational terms, even if not in credit risk terms.
Don't hesitate to contact us if you want to review those or similar issues.