Banks Build New Tools to Shift Short-Term Borrowing
January 26 2020 - 7:29AM
Dow Jones News
By Julia-Ambra Verlaine
Investors are starting to trade complex derivatives tied to the
Federal Reserve's preferred replacement for the London interbank
offered rate, a sign the financial industry is coalescing around a
new benchmark for short-term interest rates.
Banks and exchanges are expanding a market for secondary
financial products tied to this rate -- the secured overnight
financing rate, or SOFR -- easing worries that lenders and other
financial institutions remain underprepared for the shift.
The CME Group this month began offering options on SOFR
interest-rate futures and nearly two dozen SOFR options contracts
have traded since the Jan. 6 launch. And JPMorgan Chase & Co.
recently sold its first option allowing a client to enter a
so-called interest-rate swap tied to SOFR, at a future point in
time.
"This is a good step forward towards developing SOFR derivatives
markets, " said Gil Holmes, head of global nonlinear-rates trading
and co-head of North America rates trading at J.P. Morgan.
The latest developments build on the growth of futures and swaps
markets launched by the CME Group in 2018. Average daily volume of
SOFR futures contracts has exceeded 33,000 so far in January, a
jump of 75% from January 2019, according to CME. Data shows swap
volumes rising throughout 2019 as well. The cumulative notional
value of CME SOFR swaps traded through December 2019 was $44.4
billion.
That is encouraging to some analysts because the transition
marks a key shift for financial markets. Libor underpins trillions
of dollars worth of adjustable-rate financial contracts, from
corporate loans to home mortgages. The benchmark, which took
decades to work itself into the financial system, was slated for
replacement by the end of 2021.
"If this transition is to be successful, then it's not enough
for just a swaps market to develop," said Timothy High, a senior
interest-rates strategist at BNP Paribas. "You will need other
derivatives markets and options products in SOFR form."
Created by a Federal Reserve committee of regulators, banks and
asset managers, SOFR was designed to be more reliable than Libor.
While Libor is derived from estimates of what it costs banks to
borrow from one another over different short-term periods, SOFR is
based on the cost of transactions in the market for overnight
repurchase agreements, or repos. That is where financial companies
borrow cash overnight using U.S. government debt as collateral.
Derivatives trading is particularly important for SOFR's
acceptance in the market because investors, asset managers and
corporate treasurers commonly use them to protect against potential
losses from things including swings in interest rates.
About $190 trillion of the $200 trillion in financial deals
linked to Libor are in derivatives contracts, according to the New
York Fed.
Daniel Kruger contributed to this article.
Write to Julia-Ambra Verlaine at Julia.Verlaine@wsj.com
(END) Dow Jones Newswires
January 26, 2020 07:14 ET (12:14 GMT)
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