As the readers of Risk.net are keenly aware, reference rates are critical to our financial system, and for that reason, must be held to the highest standards of governance and data integrity.
The secured overnight financing rate, or SOFR, is based on transactions in one of the deepest and most liquid markets in the world, and is supported by the use of multiple data sources and transparent governance procedures to ensure its resilience and accuracy.
A Risk.net article published last month characterised the New York Fed’s use of its contingency data procedure, which it employed to produce SOFR and other Treasury repo reference rates for May 31, 2019, as “a mystery”. This is misleading. The complete data contingency policy, with an illustrative example, is available on the New York Fed’s website, and its use to produce SOFR on May 31 was noted at the time of publication.
As this was the first time these rates were produced under this procedure, there is an opportunity for the public to better understand what rate production under contingency looks like.
SOFR for 31 May
SOFR, the Alternative Reference Rates Committee’s preferred replacement for US dollar Libor, is a broad measure of the cost of borrowing cash overnight collateralised by Treasury securities. It is based on actual, observable transactions and reflects more activity than any other Treasury repo rate available, with recent volumes averaging more than a trillion dollars each day. The overnight transaction data that SOFR represents are collected from the Depository Trust & Clearing Corporation and Bank of New York Mellon for each business day.
On the morning of June 3, one of the data sources used to produce the three Treasury repo reference rates, including SOFR, was unavailable. Fortunately, SOFR was designed to be operationally resilient in the face of just such a challenge.
In practical terms, the contingency policy says that if data for a given market segment are unavailable, we will pull data from a daily survey of our primary dealers’ borrowing activity in that segment. We receive data on this borrowing activity every day for each of the market segments covered by the primary data sources in our reference rates.
This contingency data is used to calculate a change in the general level of rates in the market segment for which data are unavailable since the last date in which the primary data were available. We then apply that change in rates to each transaction in the most recently available primary data for that market segment.
Lastly, we combine the results of that exercise with the current primary data for the unimpacted market segments to calculate the day’s rates.
The daily survey of primary dealers is a detailed account we collect from each primary dealer of their actual overnight trading activity in the secured overnight funding markets covered by SOFR. It is robust, but collected separately, by market segment, and is thus very useful when a primary data source for a particular segment is unavailable.
Using the relevant portion of this backup data, SOFR was produced for May 31 and published as expected on June 3. A footnote in the publication noted the use of the contingency procedure, and the New York Fed responded to questions it received by directing inquiries to these policies.
Later that morning, the New York Fed received the previously unavailable data and recalculated the rates as dictated in our rate revision policy, which is also available on our website. It states that if data become available subsequent to rate publication but on the same day, the rates are recalculated and may be republished at approximately 2.30pm if the rate changes by more than one basis point.
We did not restate the rate for May 31 because it did not change by more than one basis point between publication using contingency data and subsequent calculations using all primary data sources.
Robust and resilient reference rates
While questions are bound to arise whenever a new process is deployed, market participants should have every confidence in the robust, resilient and, notably, transparent production methodology for SOFR. To that end, participants can find all relevant information, including our methodology, policies and historical data on the New York Fed’s website, and, as always, the New York Fed stands ready to answer questions.
Suzanne Elio is vice-president, head of corporate communications, at the Federal Reserve Bank of New York