With the recent changes in market infrastructure and in the regulatory framework the importance of overnight benchmarks has increased in the last years and is expected to increase further. With that increased importance, the market will look for source of liquidity for overnight based derivatives beyond the traditional OIS. In its document on SONIA as the RFR, the The Working Group on Sterling Risk-Free Reference Rates calls for the development and promotion of interest rate derivative products which reference the RFR, including the design of a futures contract.
At a couple of days interval, CurveGlobal and CME have announced their plans to launch new overnight benchmark based futures. In the case of CurveGlobal, the futures is called Three month SONIA futures. The launch is planned for Q2 2018. In the case of CME the futures is called CME Three-Month SOFR Futures. The launch is planned for 7 May 2018. The CME futures is based on the Secured Overnight Financing Rate (SOFR). The SOFR rate is published by the Federal Reserve Bank of New York in cooperation with the U.S. Office of Financial Research. The rate publication started on 2 April 2018 and was discussed briefly in two previous blogs (here and here).
In a recent working paper, I describe the detailed futures instrument cash-flow and propose the pricing, including the convexity adjustment, of the new instrument in the collateral framework using a Gaussian HJM-like model. The paper is called
The adjustment obtained is relatively similar to the one obtained for LIBOR futures (see for example Eurodollar Futures and Options: Convexity Adjustment in HJM One-Factor Model) when the stochastic nature of the LIBOR/OIS spread is ignored. Some extra small adjustment need to be added to take into account that the futures settles only at the end of the accrual period while the LIBOR futures settle on fixing at the start of the underlying deposit period.
This futures is a new products that may help to bridge the gap between OTC and ETD in the overnight indexed products. It has still several inconvenient features that makes it difficult to be used as a building block to build an overnight yield curve up to 30 years as required by the market. Most of those drawback would be solved if the market was to adopt a design closer to the one I proposed some years ago.
I will continue to preach for the alternative design and don’t hesitate to contact me if you are interested by my sermon!