SOFR Usage Expands Despite Crisis

At a Glance

  • Open interest in the Secured Overnight Financing Rate hit 612,000 contracts in March
  • Surprise rate cuts and easing by the Federal Reserve contributed to this increase

The unprecedented turmoil that COVID-19 has brought to financial markets has not slowed down activity in the new U.S. interest rate benchmark, the Secured Overnight Financing Rate (SOFR).

SOFR measures the cost of borrowing cash overnight using Treasury securities as collateral.  SOFR is the U.S. Federal Reserve’s Alternative Reference Rate Committee’s recommended alternative to LIBOR. Traditionally, LIBOR has been the main indicator of interest rates around the world.

At nearly two years old, SOFR futures products are still in their infancy relative to Eurodollar futures, which have been trading for almost 40 years.

But SOFR futures continue to surpass expectations, despite tough market conditions.

Hand in Glove

SOFR futures are among the fastest-growing new products in CME Group’s 172-year history, with average daily volume reaching over 62,000 contracts per day during February and March and peak open interest hitting 612,000 contracts in March.  Options on Three-Month SOFR Futures, which launched in January, also saw growing volume in March.

A supportive family is key to any youngster’s healthy development.  SOFR futures are no exception.  The new products have benefited enormously from sharing a platform with CME Group’s other Short Term Interest Rates products, including Eurodollar and Fed Funds futures.

The ease of spreading across interest rate products has contributed significantly to the development of SOFR liquidity.  Spread trading between Three-Month Eurodollar futures and Three-Month SOFR futures has been particularly active in recent weeks as the ICE LIBOR-OIS spread widened to multi-year highs.

Similarly, the surprise unscheduled rate cut and additional easing by the Federal Reserve’s Open Market Committee created significant churn for both the Effective Federal Funds Rate and the overnight repo rate, which market participants managed through the One-Month SOFR vs. Federal Funds futures inter-commodity spreads (ICS).

SOFR futures are also benefiting from a steady increase in the number of floating-rate securities linked to the SOFR rate. These securities offer interest that adjusts periodically based on an interest rate benchmark.

During March, institutions issued floating-rate securities valued at around $150 billion linked to SOFR, a monthly record that is nearly three times as much as the previous monthly high.

While initial issuance was short-term in nature, notes extending further into the future have pushed outstanding notional to new highs.  With increasing volumes of securities linked to SOFR, the need continues to grow for users of the benchmark to manage their risk.

Difficult Times

The unprecedented market volatility created by COVID-19 might have been expected to slow adoption of SOFR as a key benchmark.  That the opposite has happened speaks volumes about the growing market support for SOFR in all aspects: debt issuance, cleared swaps and listed derivatives.

is Global Head of Research at CME Group. He is based in London.

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