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SOFR Discounting and Curve Stripping in the LIBOR Transition

Article Quant Q&A · Author: Skrrrrrtttt
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Summary

The document discusses how the move from LIBOR to risk-free reference rates affects swap discounting and curve construction. It describes the market shift to SOFR discounting for US swap quotations and cleared swaps, and explains that an existing projection curve for a LIBOR tenor could be paired with SOFR discounting rather than the previous overnight-index discounting approach. It also notes that major European clearing houses adopted relevant RFR discounting for cleared euro swaps.

The answer expects LIBOR liquidity to decline after fallback arrangements take effect, making RFRs the main reference rates and reducing the role of traditional dual-curve stripping. It identifies differences between clearing houses, such as CME and LCH, as a possible remaining source of curve basis. These are market-practice observations tied to the transition period described; the response is brief and does not provide pricing formulas or a full treatment of curve construction.

Key ideas

  • SOFR became the discounting basis for US swap quotations and cleared swaps in the transition described.
  • A tenor-specific LIBOR projection curve could be paired with SOFR discounting during the transition.
  • The answer expects RFRs to become the main reference rates as LIBOR liquidity declines.
  • Differences between clearing houses may sustain basis-related curve distinctions.

Tags

Fixed incomeDerivatives pricingUS markets
Full text
# Transition to SOFR Swaps and single curve pricing


# Transition to SOFR Swaps and single curve pricing












As in the US there is a push to replace IBOR based swaps with SOFR rate does that mean that SOFR swap pricing will return to using a single curve framework as LIBOR swaps did pre the financial crisis?

## Answer by AKdemy (score 8, accepted)

https://quant.stackexchange.com/a/63631

I think the question was about dual curve stripping.

As much as I know, the market is using SOFR discounting for all sorts of quotations now. For example, swaption vol is quoted with SOFR discounting, CME and LCH moved to SOFR PAI and discounting on Oct. 16 2020 on new AND legacy swaps.

For EUR cleared, major CCPs did this since July 27 2020.

The market switched to discounting with the relevant RFR rates on the dates above. Hence, if you have a dual stripped curve (e.g. 3m US libor), you use SOFR and no longer OIS (FF).

ISDA fallbacks will apply from 31 December 2021 for GBP, JPY, CHF and Euro-LIBOR and from 30 June 2023 for USD LIBOR. Even if there were some synthetic or "zombie" Libor after it officially ceases to exist, it is expected that liquidity will drop significantly. Note that the FED have issued supervisory guidance encouraging banks to “cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021”.

Once Libor is gone, your major reference is RFR. As such, you do not have dual curve stripping. The only remaining "dual curve" logic should be having CME vs LCH stripped curves to account for the basis due to IM imbalances at CCPs in my opinion.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.