The secured overnight financing rate is now the predominant benchmark across large swathes of US interest-rate derivatives markets, according to traders and market data, as the shift away from US dollar Libor has accelerated in recent months.
Volumes in SOFR-linked interest-rate swaps have averaged nearly 12,000 trades a week since late February, ISDA data show, more than double the amount of activity in US dollar Libor swaps and equivalent to about US$1.1trn in SOFR-linked trades passing through the market each week.
Listed derivatives markets have also made strides this year, with daily volumes in SOFR futures twice in recent weeks outstripping Eurodollars, the Libor-linked contracts that have long been a mainstay of rates trading markets.
The progress will encourage regulators as they seek to rid markets of Libor, the controversial bank lending rate that will – in theory, at least – cease to exist altogether from the middle of next year. Over-the-counter derivatives in particular have been a focal point of the industry transition to regulators’ preferred replacement benchmark of SOFR, having accounted for more than three-quarters of the US$220trn or so of US dollar Libor exposure spread across financial markets.
“From what we’re seeing, things are really positive, particularly when it comes to the OTC derivatives market. SOFR is not just seeing greater volumes – it has become the more liquid product right now,” said Ann Battle, head of benchmark reform at ISDA.
The US has been a laggard when it comes to eradicating Libor, which now hardly ever trades in sterling, yen or Swiss franc swaps markets. US regulators have sought to turbo-charge the transition over the past year with a series of initiatives, including banning banks from offering clients new Libor-linked swaps trades from the start of 2022 unless it’s to unwind legacy positions.
ISDA data show an average of US$1.1trn of Libor-linked trades have passed through the market each week since late February, though traders say those figures may inflate the true value of activity occurring. They also note that the scale of Libor-based business that needs to transfer to SOFR is enormous, including US$81trn in interest-rate swaps alone, according to Federal Reserve calculations at the end of 2020.
“We still see some Libor business, but it usually comes in the form of lists, suggesting that some accounts are transitioning residual Libor positions into SOFR,” said a senior rates trader at a major bank. “SOFR has been taking the lead – we see much more volume than on Libor.”
Futures progress
There has also been notable progress in futures markets, which had initially been slower to make the switch. Non-bank trading firms play a more prominent role in these markets, limiting the ability of regulators to force a shift.
SOFR futures equated to 10% of Eurodollar volumes in December, according to CME Group, but that had jumped to 70% as of early May. SOFR also surpassed Eurodollars daily trading volumes for the second time on May 3, with 1.4m contracts changing hands.
“It’s simply a case of more people becoming comfortable with SOFR as a benchmark. Almost all of our customers – well over 90% – are now trading in a SOFR world,” said Mark Rogerson, head of interest rate products for EMEA at CME Group. “Liquidity is now equivalent and in some cases stronger in SOFR, particularly for packs and bundles," he said.
CME Group has announced a “SOFR First” initiative for listed options in June and July to encourage greater trading in these contracts, where adoption of the alternative rate has been more sluggish.
SOFR daily options volumes have averaged about 123,000 contracts since late April. That's roughly 12% of Eurodollar options volumes during that period, but still a marked improvement from the average daily volumes of 36 contracts last year.
“The increased usage of futures, along with additional factors and efforts, is driving increased usage of options,” said Rogerson. “We always expected options to be behind as they need liquidity in the delta one product to build first.”
