A major boost is expected for the Sofr market next week. On July 26, the Commodity Futures Trading Commission’s (CFTC) Sofr First initiative will see USD interdealer swap conventions move from Libor to Sofr, with the goal of improving the liquidity of the Sofr market.
“We think the most critical next step for the orderly transition away from Libor in the US is to ensure that market makers and liquidity providers, remain committed to building a deep and liquid Sofr market,” said Nadia Zakir, chief compliance officer at PIMCO, speaking during the Alternative Reference Rate Committee’s (ARRC) Third Sofr Symposium.
If the July 26 transition is successful, the ARRC is also expected to formally recommend a term Sofr rate, which will be administrated by the Chicago Mercantile Exchange (CME).
The ARRC’s endorsement of term Sofr would help to reduce the risks of legacy contracts, according to Tom Wipf, chair of the ARRC. Any transactions using ARRC fallback language or the New York Libor legislation’s ‘safe harbour’ would “look to the term Sofr endorsed by the ARRC, as the first step in that waterfall.”
“The term Sofr endorsement by the ARRC, will be the key to address many of these legacy issues,” he added. “The key that we’re looking at right now is to July, 26, Sofr first, which is the path to term Sofr.”
As the ARRC edges closer to recommending term Sofr, they have also published guidelines on best practices and uses cases for the term rate. For the most part, the ARRC does not recommend term Sofr for the “vast majority” of derivatives and has only recommended its use in the corporate lending market.
Certain segments of the market, like mid-market lending are waiting for a term Sofr rate as part of their Libor transition, according to Alice Wang, managing director of fixed income at JP Morgan.
“Many of our mid-market and smaller corporates are interested in having something that they understand, they can hedge directly and can operationalise with a certain amount of ease.”
“The term rate really is a great addition to overnight Sofr averages. It’s a great win for the broad client base,” she said.
US regulators hope Sofr First will mimic the success of the UK’s Sonia First initiative. The latest statistics from the International Swaps and Derivatives Association saw 60 percent of GBP over-the-counter (OTC) and exchange traded interest rate derivates in June referencing Sonia, compared with only six percent using Sofr.
“It’s vitally important that market participants get behind this [Sofr] initiative”, said Arif Herali, senior advisor at the Bank of England.
“From my experiences with Sonia First this is primarily about changing behaviour. Having firm dates that everyone can work towards helps to focus minds, as well as to break some of the chicken and egg issues regarding liquidity and address some of the concerns around first mover disadvantage.”
RFR First
Looking beyond the initial Sofr First changes on July 26, the CFTC’s Market Risk Advisory Committee has also recommended interdealer cross-currency swaps involving USD, JPY, CHF and GBP also be moved to a “RFR First”. This has been endorsed by the ARRC along with regulators from the other currency jurisdictions.
However, this would only affect swaps conducted in those four currencies.
“There’s still an open question as to what happens with other cross-currency pairs with a [USD] leg,” said Herali.
With US supervisory guidance calling for the end of all USD Libor trading by December 31 and 90 percent of cross-currency swaps referencing USD “this is something that most non-Libor jurisdictions are going to have to grapple with over the next few months”, added Herali.