Finadium: The SOFR Transition: Benchmarks, Futures and P&L

This Finadium research report examines a number of aspects of the SOFR transition. SOFR is an overnight secured rate while LIBOR is an unsecured term rate. LIBOR, in the form of Eurodollar futures, has a deep futures market with transparent forward curves. SOFR has a brand new futures market with volume too low to reliably create much of a forward curve. Hundreds of trillions of notional dollars of derivatives are indexed from LIBOR but barely anything yet on SOFR. SOFR is growing fast however and will be unavoidable. As with many concerns in financial markets, the big one here is who will make or lose money in the transition?

The issues and challenges associated with moving away from LIBOR – what has been called “the most important number in the world” – are complex. And the market has until the end of 2021 to get it all done. The good news is that regulators, dealers, and investors know this is coming and what the successor benchmarks will be. But the real work is just starting and there is no guarantee that the cure won’t be worse than the disease.

In the US, the Alternative Reference Rates Committee (ARRC) has chosen the Secured Overnight Financing Rate (SOFR) to replace LIBOR. This new rate is based on executed repo transactions, as opposed to unsecured and often hypothetical observations contributed by major dealers. An active transition to SOFR is underway, with new bond issues tied to the benchmark and market infrastructure gearing up to handle the change.

This report should be read by financial market participants working to transition away from LIBOR to SOFR. While it has been written with securities finance and collateral management professionals in mind, the history and future prospects of US rate benchmarks have implications for a broad cross-section of the market.

Finadium subscribers to our Securities Finance, Collateral and Derivatives series can log in here to access this report.

A direct link to the report for Finadium research clients, when logged in, is https://finadium.com/finadium-report-desc/sofr-transition-benchmarks-futures-profit-loss/

For non-subscribers, more information is available here.

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