As the transition from LIBOR to SOFR gains momentum, regulatory agencies, market infrastructure firms and market participants are collaboratively working towards a seamless migration. SOFR has gained traction as a preferred alternative to USD LIBOR due to its robust underlying transactions and alignment with the overnight Treasury repurchase agreement (repo) market.  
The transaction-based nature of SOFR is not only ensuring greater stability but also creating a surge in trading activity particularly in the OTC markets. Within the OTC markets, SOFR, OIS (Overnight Indexed Swap) trades rose in March 2023 as the banking crisis created volatility and SOFR was the most liquid source of interest rate hedges. The increased liquidity resulting from SOFR OTC trades, coupled with strong trading volumes in interest rate derivatives, futures contracts, and repos, is a testament to the success of this transition and the strengthening of capital markets. Volume statistics by Clarus¹ show that by the end of 2022 there was a 350% YoY increase in SOFR USD Swaps ($60.5 trillion).

 

 

SEF SDR Data period: 02 Jan – 31 Apr 2023

Data source: Clarus Financial May 10, 2023

 

 

Benefits of SOFR to Instrument trading

The surge in trading volumes signifies a broader acceptance and adoption of SOFR as a reliable alternative to LIBOR. SOFR OTC trades bring multiple advantages to market participants. They promote enhanced price discovery, tighter bid-ask spreads, and reduced transaction costs. Additionally, increased trading volumes provide investors with greater confidence in executing trades and managing their exposures effectively. 
Clarus' analysis of the SOFR market reveals that a significant portion of trading activity is concentrated in four primary instrument types: Outrights, Spread-overs, Switches, and Butterfly Instruments. These trades not only contribute to the overall liquidity of the SOFR market but also demonstrate market participants' growing confidence in the benchmark rate. 

 

According to Clarus SOFR Swaps in the IDB (inter-dealer broker) market trade primarily as Spread-overs to US Treasuries. This is the most frequently traded instrument, with the highest notional volumes and dv01 terms and as such are the most important in setting prices of SOFR Swaps.
 

 

% D2D Trades

 

 

SEF SDR Data period: 02 Jan – 31 Apr 2023

Data source: Clarus Financial May 10, 2023

 

Glossary

Dv01

The interest rate risk of bond or portfolio of bonds by estimating the price change in dollar terms in response to change in yield by a single basis point.

 

 

SOFR Swap Trade Type

Spread-over UST

Fixed rate risk transfer vs floating rate (SOFR), Bid/Ask levels quoted in bps spread to corresponding US Treasury benchmark issue. Prevalent in Dealer-to-dealer market.

This represents 68% of D2D trades.

 

 

Butterfly

Fixed rate risk transfer vs floating rate (SOFR). Bid/Ask levels quoted in bps spread of 3 distinct tenors. The shortest and longest maturity legs are traded in equivalent directions; the risk of the intermediate maturity leg is equal and opposite to the sum of the other two legs.

This represents 19% of D2D trades.

 

 

Switch

Fixed rate risk transfer vs floating rate (SOFR). Bid/Ask levels quoted in bps spread of the simultaneous purchase and sale of two distinct tenors.

This represents 8% of D2D trades.

 

 

Outright

Plain vanilla IR Swap trade – Fixed rate risk transfer vs floating rate (SOFR). Prevalent in Dealer-to-customer market.

This represents 4% of D2D trades.
 

 

1. Clarus FT

 

 

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