Surge in SOFR Derivatives Bodes Well for Shift

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A rush of additional trading in derivatives linked to the heir presumptive to Libor bodes well for the transition to a new standard reference rate for dollar funding markets.

Activity in interest-rate swaps linked to the Secured Overnight Financing Rate has surged this month, with volume reaching $84 billion as of Oct. 21, a near tripling of the figure for all of September, according to an analysis of CME Group figures by TD Securities. Trading has risen in the wake of the so-called big-bang switch for swaps, which saw SOFR replace the effective federal funds rate in calculations that value the instruments, and the launch of a new legal protocol to open the way for a wider adoption of alternative benchmarks.

The International Swaps and Derivatives Association, or ISDA, is helping to pave the way for Libor’s demise with its announcement of new standadized contractual language that will allow firms that haven’t fully prepared to incorporate transition clauses into their agreements.

The next key milestone in the shift to SOFR is the announcement from the U.K.’s Financial Conduct Authority -- which oversees Libor -- on the exact endpoint of its reference rate. That could come as soon as November or December, according to TD rates strategists Priya Misra and Gennadiy Goldberg.

“An announcement that Libor is no longer representative by FCA would provide the necessary trigger to ‘set’ the spread” between the two benchmark reference rates, they said. While the market is already pricing in the shift, “this would make Libor going away a certainty and put the pre-cessation trigger for derivatives into effect.”

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