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Article

SOFR monthly transaction activity — October 2020

Date:
November 2, 2020
  • kevin jones headshot

    Authors

    Kevin Jones

    Managing Director
    Treasury Advisory

    Corporates | Kennett Square, PA

Summary

Each month, our team reviews and discusses the current state of USD LIBOR and SOFR markets, exploring the performance of the indexes as well as the borrowing and derivatives markets around them.

Since the U.K. Financial Conduct Authority’s 2017 announcement that it would not support LIBOR beyond 2021, market participants have been progressing towards the adoption of replacement indices. This process has moved slowly to date, but with critical deadlines approaching over the next 18 months, U.S. market participants can expect for SOFR-based transactions to become more prevalent.

This update addresses the current state of USD LIBOR and SOFR markets, exploring both performance of the rates and the borrowing and hedging markets that surround them.

What’s new?

Following the CCP discounting switch on October 16th, SOFR trading volume increased relative to LIBOR, almost doubling its relative ratio from September. The week ending on October 23 set record highs for both trade count and total notional traded with 1,302 trades and $102.8 billion in notional representing 22% and 11% of SOFR trades in 2020 respectively.

The five-year historical median spread between both 1-month LIBOR and 1-month SOFR and 3-month LIBOR and 3-month SOFR remained around 11 bps and 26 bps, respectively, as they have since August.

On October 23, ISDA launched the IBOR Fallbacks Supplement and Protocol, which established a framework for transitioning interest rate derivatives from USD LIBOR to SOFR. For more information about the Protocol, read our summary of ISDA’s IBOR Fallbacks Protocol FAQ.

Performance of USD LIBOR and SOFR

Figure 1. The spread between 1-month LIBOR and SOFR compounded in arrears reflects the spot difference between the rates, as opposed to the historical five-year median spread adjustment on that date. Source: Chatham Models and Historical Benchmark Data.

  • USD LIBOR and SOFR compounded in arrears, the primary backward-looking calculation methodology recommended by ISDA (unless otherwise indicated, all subsequent references to SOFR will mean SOFR compounded in arrears), tend to be highly correlated and directionally aligned.
  • The spot difference between LIBOR and SOFR tightened slightly in October, averaging about six basis points, down from an average of about seven basis points in September.
  • For more information about SOFR, read SOFR: An end user’s guide.

USD LIBOR to SOFR spread adjustment

Figure 2. Spread adjustment between LIBOR and SOFR compounded in arrears for 1-month and 3-month tenors. Source: Chatham using historical benchmark data.

  • The five-year historical median spread held steady at around 26 basis points for a 3-month tenor and 11 basis points for a 1-month tenor. The spreads have been relatively consistent since August.

Hedging activity in USD LIBOR and SOFR markets

Figure 3. Transaction volume and count comparison of USD LIBOR and SOFR-based derivatives. Source: ISDA SwapsInfo.

  • As of today, LIBOR continues to be the primary index hedged in the market, with SOFR orders of magnitude behind in both transaction volume and count.
  • SOFR transaction count and volume increased significantly in October as compared to previous months. The increase coincided with the CME and LCH discounting switch to SOFR (see Chatham’s SOFR Forward Curve Update and the CCP “Big Bang”).
  • Some expect transaction volume and count to pick up as Freddie Mac and Fannie Mae continue their transition from LIBOR to SOFR as the index underlying ARMs and SARMs. For more information about this transition, please read our FAQ: USD LIBOR transition to SOFR.

Figure 4. SOFR derivative transaction volume by tenor. Source: ISDA SwapsInfo.

  • October saw the largest increase in SOFR derivative transactions to date. The first month of Q4 accounted for about 25% of the SOFR derivative transactions in 2020 to date.

Figure 5. Transaction volume represents notional hedged (USD billions) for new SOFR-indexed derivatives. Source: ISDA SwapsInfo.

  • Total SOFR transactions by volume remained relatively consistent from Q2 to Q3 2020, however there was some movement in the proportional breakdown by tenor.
  • Longer-tenor transactions (over five years) increased in volume, as well as by count, by about 700%.

Speak to a Chatham expert

Please reach out to the Chatham team if you have questions around the USD LIBOR transition or how the use of SOFR in your loans and derivatives could affect your interest rate exposure.

About the author

  • Kevin Jones

    Managing Director
    Treasury Advisory

    Corporates | Kennett Square, PA

    Kevin Jones serves Chatham’s corporate clients in interest rate and foreign currency hedging advisory. Kevin’s expertise spans risk quantification and analysis, hedging strategy development, market dynamics, and trade execution.

Disclaimers

Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.

Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.

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