Why CME Uses SOFR Futures to Set Term Rates
Summary
The document asks why CME derives forward-looking Term SOFR rates from SOFR futures rather than the SOFR overnight index swap curve. It contrasts the transparency and liquidity of those markets and notes that one-month SOFR futures settle against an arithmetic average, while three-month futures and OIS floating legs use compounded rates. This raises the possibility that arithmetic averaging makes one-month futures a better fit for some term-rate uses.
The accepted explanation emphasizes market access and governance: CME controls its futures market and can observe its trades, whereas OTC swap reporting and access to swap prices can be less timely or consistent. Futures provide enough information to infer term indices, but the described approach assumes convexity adjustments are zero because CME lacks transparent inputs for estimating them. The discussion presents this as a likely explanation, not a definitive account of CME’s methodology, and does not resolve whether averaging conventions are also a factor.
Key ideas
- CME futures are observable within a market it operates and regulates.
- OTC OIS prices may be harder to collect consistently and promptly.
- One-month SOFR futures use arithmetic averaging, while three-month futures use compounding.
- The described implied-rate approach assumes zero convexity adjustment because transparent inputs are unavailable.
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# Term SOFR rate formula # Term SOFR rate formula The following website gives the specifications of the CME Term SOFR reference rates: CME Term SOFR. Point 1 in the link above specifies that the tenors that are currently supported are 1m, 3m, 6m, and 12m. Point 2 specifies that CME SOFR futures of various maturities are used to imply the SOFR Term rates (the maturities differ, but the underlying accrual period is always either 1m or 3m). Point 7 specifies that the Alternative Reference Rate Committee (ARRC) supports the introduction of SOFR Term rates. My question is this: why do you think that the CME uses SOFR futures, rather than SOFR OIS swaps, to imply the SOFR Term rate? January 2022 data show that EuroDollar futures (i.e. USD Libor futures) were still 3-times more liquid in terms of volume than the SOFR equivalent. On the other hand, SOFR OIS swaps have by now far exceeded LIBOR swaps in terms of liquidity. Why not just use the OIS SOFR swaps? Why is the market obsessed with trying to come up with some "fancy" SOFR term rate (such as the CME SOFR term rate, which mixes various SOFR futures and uses an opaque formula based on VWAP): I totally understand that the market wants a forward looking credit sensitive rate (for example to index lending to): but why not just take points on the SOFR OIS yield curve as the forward-looking SOFR term rate? My only possible explanation is that the SOFR OIS curve is based purely on a compounded rate, whilst the market might fancy some type of an arithmetic average rate: when you undertake overnight financing, you do it on a non-compounded basis (you borrow a fixed amount, pay prevailing interest rate, and then might chose to borrow the same fixed amount again and pay the new prevailing overnight rate: therefore arithmetic average might be better for hedging, rather than a compounded average). The SOFR futures link above specifies that the CME 1m SOFR futures use an arithmetic average daily SOFR during the delivery month to compute the settlement rate, whilst the CME 3m SOFR futures use the compounded daily SOFR during the delivery quarter to compute the settlement rate. To my knowledge, the SOFR OIS swaps use the compounded average for the SOFR floating leg (so presumably the same formula as the 3m CME futures). So the 1m SOFR futures might be better for a forward-looking SOFR Term rate based on an arithmetic average. Is it the arithmetic vs. the compounded rate argument, or is there a different reason for not using the SOFR OIS swap curve to imply a SOFR Term rate? ## Answer by Attack68 (score 7, accepted) https://quant.stackexchange.com/a/70326 The issue is data ownership and transparency in my view. Whilst OIS-swaps do give a more accurate view of the daily RFR rates that will compound to yield the Term SOFR reference rates, the OIS swaps are not reliably visible and they and are out of CME's control. CME SOFR futures are directly within CMEs control and their pricing and transactions are regulated by the CME Regulatory reporting of SEF trades requires OTC OIS swaps be reported but timings are not entirely robust and much more difficult to coordinate across all register SEF entities. CLOB are also difficult or impossible for CME to gain access to determining the OIS-mid swap rates at any given time. The SOFR futures contain enough information to determine the SOFR tenor indices except for convexity adjustments, which are obviously assumed to be zero, since the CME also has no transparent way of determining this information, except to offer options on SOFR futures from which it could determine a transparent volatility parameter (within its own sphere of influence) and devise a public formula that will include convexity adjustments.
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