Quick Takes: Term SOFR and BSBY Volumes – October 2023
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Ali Curi: Hi everyone, and welcome to ION Markets Quick Takes. I'm Ali Curi, and every week, along with our guests, Amir Khwaja and Chris Barnes, we take a quick dive into the headlines on the Clarus blog. Let's get started. 

Hi, Amir. Hi, Chris. 

Amir Khwaja: Hi, Ali. 

Ali Curi: It's great to have you here. Welcome back to Quick Takes.

Amir, let's start with you. What are your Quick Takes for this week? Which headline from the Clarus FT blog would you like to discuss? 

Amir Khwaja: It's called "Term SOFR and BSBY Volumes October 2023." 

Ali Curi: Okay, sounds good. Let's get started. 

Amir Khwaja: So I think when LIBOR transition was announced, there were two concerns with LIBOR.

SOFR is not a term rate, it's an overnight index rate, and it's not forward looking in terms of tenor, and it didn't include credit risk of the banking sector. So a few vendors, I think mainly Bloomberg and ICE launched. So Bloomberg launched BSBY, Bank Short Term Bill Rate. That was seen as an alternative to LIBOR in terms of the transition away because it had a credit spread for the banking sector and it's a term rate forward looking. A lot of effort went into BSBY, the clearinghouses launched contracts and you could clear BSBY CME launched Futures.

But I think finally we're seeing some small Volumes, but they're now heading down to zero and Bloomberg have announced that BSBY will end shortly. So really the market has voted to migrate from LIBOR to SOFR, which was the official Federal Reserve of New York backed replacement rate for LIBOR.

So I've been tracking volumes in BSBY, so then that looks like it's coming to an end. And then the other rate is Term SOFR. So because SOFR is a daily averaging rate, there was a concern that the market needed a forward-looking term rate like Term SOFR. And really there are two variants. There's CME, they published a forward looking Term SOFR and the Federal Reserve of New York published an average backward -looking rate.

So there is some Volume in those. So there's about a thousand trades a month in Swaps and Terms, a bit lesser in Average SOFR. So each quarter I track how these alternative rates are doing compared to the normal Overnight Index SOFR. And that's what the blog looks at. So I'd say of all the products, it seems in Cap Floors, there's more of an uptake of Term and Average at SOFR than Swaps.

The Volumes are almost comparable or trade comes incomparable between SOFR on Caps and Term SOFR. But on Overnight Index Swaps, there's tiny Volume in Term and Average SOFR compared to SOFR. So that's what the blog looks at.

Chris Barnes: Amir, it looks only at Swaps. 

Amir Khwaja: Predominantly, yes.

Chris Barnes: I should say it looks only at OTC Derivatives.

Amir Khwaja: Correct.

Chris Barnes: So do we know if loans are still being originated at the same pace versus Term SOFR and BSBY?

Amir Khwaja: Good point, yeah. So there is a website where I think the ARC does publish the Federal Reserve New York Committee. I'm not checked in a while how that's doing. There's the OTC Derivative Market, the Loan Market, the Futures Market.

I'm not sure what's happening in the FRN-type Floating Market. 

Chris Barnes: And do you think it's notable that the Volumes and Swaps have decreased after Dollar LIBOR cessation? It looked at one point at the beginning of this year, that Term SOFR was going to be a meaningful product, right?

And I know I spoke to some of the brokers and they were keen to start broking the basis between Term SOFR and SOFR. 

Amir Khwaja: Yes. Good point. No, I think it has fallen off. And even the basis trade between Term SOFR and SOFR has dropped quite significantly since the summer. Since the conversion at CME LCH, upsell portfolios.

So it's not obvious to me where Term SOFR is heading in swaps markets. It does seem to be ticking down quite substantially from a upward tick. 

Chris Barnes: Fair enough. I guess the outlook for BSBY is clearer in that it's pretty much, it's guaranteed to cease now, I guess. Have you had a chance to look at what it will fall back to?

I guess it'll fall back to SOFR plus a spread of some sort? 

Amir Khwaja: Good question, Chris. So I guess, so they're clearly Swaps out there that are going to be three or five year and there'll be an ending. What other choice is there? Has to be SOFR plus a spread. 

Chris Barnes: I guess the benchmark administrator will have to put out a consultation.

The whole point that these Swaps were written is that mainly by end users that can't deal with compounding and paying with a couple of days notice. How are the constituents that have actually used the Swaps going to agree to fall back to SOFR, which is then just a compounded rate? It seems a pretty gnarly question to try and answer for the benchmark administrators.

Amir Khwaja: Good point. Maybe it'll be CME Term SOFR fall back. I don't know. But you'd be right. So there has been a consultation announced. I've not followed up with the results, but worth checking. I'm sure Bloomberg will get feedback on the fallback, in the consultation, or I guess they may have to keep it.

Mind you, can't keep publishing five years, right? So obviously if the five year Swaps out there, they must seize before the last Swap auctions. I don't know. Maybe there'll be auctions to close them out. 

Chris Barnes: I guess virtually all of the BSBY outstanding Volume is CCP cleared because I don't think we saw any Volumes in BSBY Swaps until it was clearable at CME and LCH.

Amir Khwaja: And it's pretty low, it's pretty small Volume, even in CCP cleared. 

Chris Barnes: As you say, it could be a conversion exercise that's run by the CCPs.

Amir Khwaja: And I think, our interest is, we've gone from a world where there were lots of LIBOR tenor bases, one month, three months, six months, LIBOR Fed funds, et cetera.

I guess Prime still exists and, the other rates, BMA, all the LIBOR trading has converged onto SOFR of an index swaps and the markets handled that well. Some of these alternatives have some niche uses. BSBY seems to not, is not going to be, successful in OT derivatives.

ICE Bank yield, I think it's still out there. It didn't really happen in Swaps or Futures. Average SOFR and, in Term SOFR are now niches. And that's what we follow. 

Chris Barnes: I guess the regulatory community had put their weight behind SOFR and compounded SOFR anyway.

Do we have any kind of indication whether the regulators are happy by this outcome or purely a market driven move? 

Amir Khwaja: I think it's market driven. Clearly the issue with BSBY was that the official sector, I think did put out something out saying, it didn't have enough transactions back that reference index.

And the whole point is SOFR has significant transactions that back that rate daily. So it's a benchmark that is transparent with real trades that make up that price. Whereas some of the alternatives have struggled with enough transactions. 

Chris Barnes: Makes sense, man. Thanks. 

Amir Khwaja: Back to you, Ali. 

Ali Curi: Great. Thank you, Amir. And please share with us again the title of your blog post. 

Amir Khwaja: Yes, sure. Term SOFR and BSBY Volumes, October 2023. 

Ali Curi: Perfect. That works. Chris, Amir, thank you both for sharing your Quick Takes. Let's do it again next week. 

Amir Khwaja: Thank you, Ali. 

Chris Barnes: Thanks, Ali. 

Ali Curi: And that's our episode for today. You can read more about these topics on the Clarus blog, and you can follow ION Markets on X, formerly Twitter, and on LinkedIn.

Until next week, thank you for joining us.