2018-07-03

Triple basis

In a recent Risk article (Clearers diverge on SOFR swaps discounting - subscription required) it was indicated that, contrarily to previous announcements, when CME will start to clear SOFR linked swaps, the interest used for Price Alignment Interest (PAI) will be SOFR itself and not the EFFR which is used for other USD OTC derivatives. This is also a departure from the initial ARRC suggestion. Regarding LCH, the current indication is that it will clear SOFR linked swaps with EFFR PAI.

This means that out of the six variations of overnight-linked derivatives discussed in a previous blog, five will be available in Q3. It is not certain that the sith variations will ever be really traded, but we can expect that if SOFR is becoming the benchmark benchmark (I'm not sure it is the correct term, but it seems appropriate here) at some stage some legacy EFFR OIS will switch to SOFR for collateral.

From a long term perspective, it seems logical to clear SOFR based swaps using SOFR collateral interest. Starting with EFFR collateral would mean that at some stage in the future, the CCP rule or the master agreement would need to be changed to switch to the new rate.

Now a trick questions: When will the basis swaps EFFR v SOFR start to trade/clear? What will be the PAI on those swaps?

Over the recent years we have seen the appearance of a basis between swaps traded at different CCPs. With this announcement we will see the appearance of a triple basis: on top of the CCP basis, we will have the discounting basis (SOFR v EFFR) and the "convexity adjustment" basis (on SOFR forwards). It will be impossible to untangle those basis as there will be for the moment only a limited number of traded swap types out of the multiple combinations and no option market yet.

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