How USD Swap Trading Conventions Shifted from LIBOR to SOFR
Summary
This note describes the state of the US dollar interdealer swaps market during the transition away from LIBOR. Earlier conventions included swaps paying semiannual 30/360 or annual Actual/360 rates, as well as spreads over Treasury securities. A 2021 industry initiative moved interdealer screens for linear interest rate swaps to SOFR, leaving new LIBOR swap trading nearly absent at the time of the account.
The answer says standard SOFR swaps reset using compounded SOFR in arrears. It distinguishes this backward-looking overnight benchmark from term SOFR, a forward-looking rate that may better suit loans and some nonlinear derivatives. The discussion suggests demand for a forward-looking replacement for LIBOR, but does not give pricing methodology or market data supporting that demand. SOFR asset swaps against Treasuries were beginning to gain activity, though the source cautions that this market was changing quickly and its cited account could already be dated. These observations describe the market as of January 2022 and should not be treated as current conventions without updated sources.
Key ideas
- The 2021 SOFR First initiative moved interdealer linear swaps trading toward SOFR references.
- New USD LIBOR swap trading was described as almost nonexistent at the time.
- Standard SOFR swaps reset using compounded overnight SOFR in arrears.
- Term SOFR offers a forward-looking rate that may better fit loans and some nonlinear derivatives.
- SOFR asset swaps against Treasury securities were beginning to see more activity, but the market was evolving.
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# USD swaps trading post LIBOR: the current state of the world (January 2022) # USD swaps trading post LIBOR: the current state of the world (January 2022) The USD interest rate swaps market has been transitioning from LIBOR to SOFR for some time. In the "old days" when swaps reset against LIBOR underlyings, there were a few "market convention" ways of trading swaps in the inter-dealer market. Basically, participants traded the following ways: - semi-annual 30/360 on rate - annual Act/360 on rate - vs. cash Treasury notes/bonds on spread I've been retired from trading for a long time, and have a few questions about the current state of the world: - Is there any trading of new swaps that reset against a LIBOR underlying? (or has the market fully transitioned to SOFR underlyings?) - Do swaps that trade in the inter-dealer market reset against SOFR in-arrears or some sort of calculated "term SOFR" rate (e.g. the term SOFR rates provided by CME)? - If the answer to question 2 is "swaps reset against SOFR in-arrears", then why is there all this talk about the term SOFR rate? Is the term SOFR rate just used for pricing? - Does the market actively trade SOFR swaps on spread to cash U.S. Treasuries (similar to the way that LIBOR swaps were quoted as a "spread over")? Thanks! ## Answer by Jan Stuller (score 6, accepted) https://quant.stackexchange.com/a/69500 - The Commodity Futures Trading Commission’s Market Risk Advisory Committee (CFT MRAC) went ahead with a 4-phase program in 2021 called "SOFR First": the four phases relate to linear IRS, Cross-currency swaps, futures and finally non-linear USD rates derivatives. The "SOFR first" initiave basically means that any new trades have to reference SOFR, rather than LIBOR (unless exceptional circumstances). The first phase for linear IRS went ahead in July 2021, and in practice it meant that inter-dealer brokers switched all their screens from USD LIBOR IRS to USD SOFR IRS. So the answer to your question is: new trading in USD LIBOR swaps is now almost non-existent. - SOFR in arrears - Economically, unlike LIBOR, SOFR compounded in arrears is not "forward looking". For example, banks would prefer loan products referencing SOFR to be forward looking, to be "more aligned" with markets should credit spreads suddenly widen. I think there is also appetite for non-linear derivatives to reference term SOFR. In general, the markets are hungry for a term rate that would be forward looking to "economically" replace LIBOR. - Asset swaps on USD SOFR IRS are slowly picking up, this report by CLarusFT from September 21 sheds some light on this market, although things change so fast that it's probably slightly out-dated by now.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.