CFTC MRAC Issues User's Guide on LIBOR-to-SOFR Transition for Exchange-Traded Derivatives | Practical Law

CFTC MRAC Issues User's Guide on LIBOR-to-SOFR Transition for Exchange-Traded Derivatives | Practical Law

The CFTC's Market Risk Advisory Committee (MRAC) issued a SOFR First user's guide for exchange-traded derivatives transactions. The guide addresses the transition of new exchange-traded derivatives from the LIBOR to the Secured Overnight Financing Rate (SOFR).

CFTC MRAC Issues User's Guide on LIBOR-to-SOFR Transition for Exchange-Traded Derivatives

by Practical Law Finance
Published on 23 Dec 2021 • USA (National/Federal)
The CFTC's Market Risk Advisory Committee (MRAC) issued a SOFR First user's guide for exchange-traded derivatives transactions. The guide addresses the transition of new exchange-traded derivatives from the LIBOR to the Secured Overnight Financing Rate (SOFR).
On December 16, 2021, the CFTC's Market Risk Advisory Committee (MRAC) issued a SOFR First user's guide for exchange-traded derivatives transactions (user's guide). The guide addresses the transition of new exchange-traded derivatives from LIBOR to the Secured Overnight Financing Rate (SOFR) pursuant to the MRAC’s approval of the SOFR First initiative at its July 13, 2021 meeting (see Legal Update, Updated: CFTC MRAC Recommends July 26, 2021 LIBOR-to-SOFR Transition Date for Interdealer Interest Rate Swap Market). The user's guide represents the fourth and final phase of the SOFR First initiative.
The SOFR First user's guide encourages market participants to ensure operational capability to transact in SOFR exchange-traded derivatives as soon as possible and to transition from LIBOR to SOFR for new contracts after end 2021. The guide is designed to promote understanding of the following four statements:
  • Statement #1: Eurodollar futures and options are LIBOR contracts.
    The Eurodollar futures rely on the publication of USD Intercontinental Exchange (ICE) LIBOR for valuation and settlement, making them LIBOR-based contracts. Other exchange traded products include the same dependencies. Banks and non-banks should be aware of the risks associated with these exchange-traded LIBOR contracts.
  • Statement #2: SOFR futures volumes are growing, and exposures are bigger than market participants realize.
    There has been significant growth in SOFR futures since their launch in May 2018 (see Legal Update: ARRC Publishes LIBOR Transition Progress Report and Issues Update on Forward-Looking Term SOFR Rate). The user's guide notes that open interest peaked on November 30, 2021, reaching a record 1.6 million contracts, up 136% year over year, making SOFR futures among the fastest growing products in the 170+ year history of CME Group (CME).
    As of March 29, 2021, CME adopted SOFR-based fallbacks to convert (in June 2023) CME Eurodollar contracts and cleared swaps to SOFR using the spread for 3-month LIBOR fallbacks in ISDA® documentation now fixed at 26.161 bps.
  • Statement #3: Liquidity for LIBOR contracts may decline after end-2021.
    The user's guide notes it is reasonable to expect that there will be a decline in trade of LIBOR products after 2021, potentially resulting in greater transaction costs and lower market activity after 2021 through LIBOR cessation in 2023.
  • Statement #4: CME has created products to allow market participants to efficiently transfer risk from Eurodollar futures to SOFR futures.
    To enable to transfer between benchmark rates, CME offers products between Eurodollar futures and SOFR futures for relative value trading and basis hedging. Trading of inter-commodity spread (ICS) products saw record volumes in October 2021. To encourage further conversion of these contracts from LIBOR to SOFR, CME will permit new reduced-tick SOFR futures-Eurodollar ICS trading, as of January 10, 2022.
The MRAC user's guide recommends the following best practices to those transacting in Eurodollar futures and options:
  • All market participants that currently trade Eurodollar futures and options should ensure that they are operationally capable of transacting in SOFR futures and options as well as products between Eurodollar futures and SOFR futures as soon as possible.
  • All market participants should replace use of LIBOR with SOFR for new contracts, including exchange-traded derivatives, after year-end 2021.
SOFR First includes four phases providing market best practices for transitioning certain segments of the derivatives markets to SOFR from USD LIBOR by December 31. For details, see Legal Updates: