SOFR Futures and Options

CHAPTER 8Hedging the CME Term SOFR Rate

At some level, the secured overnight financing rate is an elegant concept, as it represents the most basic building block for yield curves. But as we have described in Chapter 3, there are a significant number of market participants for whom SOFR isn't ideal. For example, many corporate treasurers appreciate knowing the cash flows of their loans well in advance of those cash flow payment dates. And for these people, a plan vanilla SOFR loan simply isn't an attractive arrangement, due to the fact that the ultimate size of each interest payment is known only shortly in advance of the interest payment date.

In theory, secured financing rates for specific terms could be constructed the way the Fed constructs the secured overnight financing rate – i.e., by averaging each day the interest rates reported for repo transactions for specific terms, such as one month, three months, and six months. In practice, however, this is seen as problematic, as the volume of daily transactions with terms of three months, six months, etc., is considered to be insufficient for this purpose.

As an alternative, someone could organize a process in which banks are asked each day to provide the rates at which they would be willing to enter into repo transactions of various terms. And then these rates could be averaged and published at the same time each day. Of course, the problem with this approach is that regulators would be unwilling to sanction a process that ...