SOFR First - Step 1.5!

One month ago we published a blog titled "SOFR First - Step 1!". This was the fist week where at LCH there was more SOFR swaps traded than LIBOR swaps. We also indicated that for STIR futures at CME, LIBOR was still well above SOFR in volume terms.

This week we can indicate that "Step 1.5" in SOFR first has been reached. The daily volume of SOFR-3M futures is still less than the LIBOR-3M one, but for the first time, there was one day (Tuesday 19 April) where the combined volume of SOFR-3M and SOFR-1M surpassed on the LIBOR-3M one. You may have received some marketing email from CME indicated this milestone — even if the mail was not clear on the fact that this was achieved only by combining SOFR-3M and SOFR-1M. If you take the contract individually, LIBOR-3M has still more volume than SOFR-3M every single day. On the 1M side, EFFR-1M has still more volume than SOFR-1M every single day. This is why we call this step by the name of "1.5". The true "Step 2" will be when SOFR-3M volume is above LIBOR-3M volume and maybe "Step 3" when SOFR-1M volume is above EFFR-1M volume.

Returning to the LCH OTC cleared side, since that first "SOFR First - step 1" week, the SOFR, EFFR and LIBOR shares have battled for the leadership. The weekly shares are provided in Figure 1. SOFR hase been the main benchmark for a couple of weeks, but still far away from registering 50% of the OTC swap volume.

Figure 1: Weekly share of product types at LCH

The volume has been flat on an absolute basis over the last 8 weeks. The increase in market share is more due to the decrease in LIBOR and EFFR than the increase in SOFR.

Figure 2: SOFR volume evolution and share among tenors.

The oustanding amount has been steadly increasing for SOFR and has now reached the EFFR level. The LIBOR outstanding amount is almost unchanged since the beginning of the year, confirming that the activity on LIBOR is not all risk reducing.

Figure 3: LIBOR, EFFR and SOFR outstanding volumes at LCH.

The daily volume in STIR futures at CME is displayed in Figure 4. The "Step 1.5" is not directly visible on the graph, but by adding the SOFR-1M to the SOFR-3M volume on 19 April, the totla is larger than the LIBOR-3M volume. Up to know, this was a one-off. We will indicate the real "Step 2" in our blogs as soon as we see it hapenning.

Figure 4: Daily futures volume at CME.

On the open interest side, the situation is a continuation of the developments since the begining of the year. An very small decrease in LIBOR open interest — indicating once more if needed that the vast majority of the LIBOR trades are not risk reducing — and a significant increase in the SOFR open interest and a smalller one in EFFR open interest. The OI in SOFR-3M futures has not reach 50% of the LIBOR-3M futures yet. The increase in SOFR and EFFR is probably linked in part to the change in monetary policy and not only to the benchmark transition. The total STIR futures OI has significantly increased since the start of the year.

Figure 5: Futures Open Interest at CME

SOFR progress: 2022-04-08

Graphs without comment this week.

Figure 1: Weekly share by product types at LCH

Figure 2: SOFR volume evolution and share among tenors.

New working paper: Options on overnight futures

We are pleased to announce a new working paper titled

Options on overnight futures

is available in our muRis_Q Advisory Model Development series of research papers. The paper is available on SSRN preprint repository at http://ssrn.com/abstract=4068731.

Abstract

With the transitions to overnight benchmarks as the main benchmarks in some currencies, futures based on overnight rates are becoming more common. The most traded futures on overnight rates settle agains compounded rates. The pricing of those futures requires some convexity adjustments with an Asian flavour due to the composition. Together with the greater liquidity of those futures came the market for options on futures. The options are traded with the usual futures daily margin mechanisms and can be standard options or mid-curve options; the options themselves are European or American. The pricing of those options, require different adjustments for the margin and composition features. In this note we propose the pricing of those options in the Gaussian HJM framework.

SOFR in 2022 Q1: slow progress

2022 was suppose to be the year where USD-LIBOR was only used for risk reduction. The end of Q1 has come and that has not happen. 

There has been progress on the LIBOR transition and on SOFR developments but they can only be qualified as "slow" and not all LIBOR transition goes in SOFR direction.

Let's start with the SOFR progress part. This is clearly visible in Figure 1 which displays the SOFR volume at LCH and as reported by ISDA (in Swap Info).

Figure 1: SOFR volume evolution and share among tenors.

The SOFR progress is clearly visible with the volume roughly tripling over the last 6 months.

On the LIBOR side, there has been a clear decrease in volume but far away of the one we would have expected from a"prohibition of new use" as decided by the FCA. Since the beginning of the year, the LIBOR volume represent roughly 31% of the USD 165 trn traded in USD derivatives at LCH. The weekly benchmarks shares are displayed in Figure 2. 

Figure 2: Weekly share of product types at LCH

One obvious feature of the market share, is that is the USD derivative market is not based on a pure LIBOR-SOFR transition, but there is a third major participant: EFFR. Even without the support of the regulators and without the automatic conversion of some LIBOR trades, EFFR represent around one third of the market. The EFFR trades are concentrated on the short end of the curve.

As explained in previous blogs, this is a problem for SOFR as the term SOFR rates (CME and IBA version) are currently not based on "level 1 waterfall" — quoted OIS in the interbank market. It makes the pricing and hedging of those terms rates and the associated basis, which in theory should be 0, relatively difficult.

On the STIR futures side, the situation is not very different. SOFR is progressing and LIBOR is decreasing, but we are still very far way from a transition. EFFR is also playing a non-negligible role. The daily volumes over the last 6 months is displayed in Figure 3.

Figure 3: Daily volumes for STIR futures at CME.

We look at the STIR futures in two blocks: the 3 months futures and the 1 month futures. The 3 months are the most liquid and composed of three types: LIBOR, SOFR and BSBY. The daily share of SOFR has been between 12.4% and 42.5%, it has never been the most traded futures on any single day. The share of BSBY is anecdotic, between 0 and 1%. LIBOR is still by far the dominant futures with more than 70% of the average daily volume. The 1 month is composed of only two types: SOFR and EFFR. The daily share of SOFR is between 8.3% and 29.7%. Fed Funds futures are still largely dominating SOFR with with around 85% of the average daily volume.