Secured Overnight Financing Rate (SOFR)

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The Secured Overnight Financing Rate (SOFR) is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities, published daily by the Federal Reserve Bank of New York, in cooperation with the U.S. Office of Financial Research starting on April 3, 2018.[1] It is based on an average daily volume of more than $1 trillion of actual transactions in the U.S. Treasury repo market.[2]

SOFR is an alternative to the London interbank offered rate (Libor). The New York Fed began publishing the rate as the first step in a multi-year plan to transition more derivatives away from Libor. [3][4]

The Alternative Reference Rate Committee (ARRC), a group of big banks, selected the rate, citing the depth and robustness of the market. The new rate was created partly in response to regulators seeking to reduce the markets' reliance on Libor, as there has been a decline in loans backing that rate. If Libor stops being published it could potentially pose systemic risks, according to Federal Reserve Chairman Jerome Powell.

Libor’s reputation was damaged when banks manipulated the rate before and during the 2007-2009 financial crisis. Libor rates are sometimes estimated rather than based on actual transactions.[5]

SOFR is designed to work alongside Libor, but regulators hope eventually institutions will transition from using Libor and move to SOFR. The Alternative Reference Rates Committee, a public-private committee convened and sponsored by the Federal Reserve, has recommended recommends institutions move from Libor to SOFR as quickly as possible.

In November 2019, the Federal Reserve Bank of New York outlined plans to produce SOFR averages along with a SOFR index. By publishing these averages on its website, which is expected to begin in the first half of 2020, the New York Fed will provide consistently calculated SOFR averages across various terms and an index to facilitate the calculation of averages over custom periods.[6]

Exchanges and SOFR Products[edit]

The CME Group launched 1-month and 3-month SOFR futures on the rate on May 7, 2018 and announced it would offer options on 3-month SOFR futures on January 6, 2020.[7][8]

LCH began clearing the first SOFR swaps in July 2018.[9]

The were problems initially with the SOFR. For example, SOFR-based derivatives instruments had trouble gaining traction. The Eurodollar Futures contact at CME Group traded roughly 1.8 million contracts ($1.8 quadrillion) on Jan. 29, 2019; the SOFR contract traded less than 1.2 thousand contracts ($1.2 trillion), according to the TABB Group, which also said there is basis risk associated with an interest rate like SOFR (overnight tenor and Treasury-related) because it is a backward-looking overnight rate and could play havoc with bank profitability during times of crisis.

The Intercontinental Exchange launched trading of ICE One and Three Month SOFR Futures in October of 2018.[10]

In August 2019, CME reported that more than 195 market participants had traded more than 63 million contracts since the May 2018 launch of SOFR futures. Open interest hit a record on August 30, 2019, surpassing 283,000 contracts.

CME launched options on SOFR futures on January 6, 2020. Ten contracts changed hands -- five lots of a straddle.[11]


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