OFR Researchers Evaluate Effect of SEC Repo Clearing Rule on SOFR
Commentary by Sebastian Souchet
Researchers from the Office of Financial Research ("OFR") evaluated the potential effect of the SEC's central clearing rule on "the level and behavior of [Secured Overnight Financing Rate], which "serves as a benchmark for borrowing cash overnight in the United States."
The researchers explained that the rule, effective June 30, 2027, will cover up to 85 percent of current non-centrally cleared repo transactions and that the inclusion of repo-rate information from cleared repos will be used to calculate the SOFR. (See related coverage.)
The researchers "estimate[d] a hypothetical SOFR that includes representative non-centrally cleared bilateral repos," using pilot data collected in June 2022 from nine sell-side firms, along with methodology from the Federal Reserve Bank of New York. The researchers found that including these repos would not have changed the published SOFR median rate for the sample dates. However, they found that adding these transactions would have modestly widened the distribution of repo rates used to calculate SOFR, slightly affecting the tails of the distribution.
The researchers noted that these findings are based on static analysis and do not account for the behavioral changes that may occur once the SEC rule is fully implemented. They stated that market participants could adjust their pricing or structuring of repo transactions in response to the balance sheet and netting benefits associated with central clearing.
Commentary
The SIFMA Asset Management Group emphasized the need for the SEC to asses the potential impact of an increased volume of cleared repo transactions on SOFR "given its importance as a reference rate replacing LIBOR and because SOFR is calculated largely based on implied financing rates of repo transactions cleared at FICC." (See p. 2719 of the Clearing Rule's adopting release.) The SEC responded saying that further study is unnecessary because the volume-weighted nature of SOFR should "allow preparation of the rate to take into account any increased transaction volume arising from additional central clearing." Given the OFR researchers' findings, it appears that the Clearing Rule—which, as a policy matter, is supposed to reduce counterparty credit risk and increase market stability—could actually increase the volatility of SOFR in some circumstances.
While the OFR researchers state that the study does not take into account the "equilibrium effects" of the Clearing Rule, it is not obvious what they are referring to, and whether such presumed effects will be realized, particularly given the various open issues the SEC still needs to consider regarding implementation of the rule.
Further, the OFR researchers state that "[i]f netting were available, [then] including NCCBR rates in SOFR might not result in such large changes in the tails of the SOFR distribution." However, as has been noted by others, the proposed Basel III Endgame framework does not recognize cross-product netting across derivatives and repo trades, thus both constraining bank balance sheets and limiting Treasury market intermediation and liquidity.
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In testimony before the Task Force on Monetary Policy of the House Financial Services Committee, industry leaders urged additional reforms in advance of implementation of the SEC's clearing mandate.
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Federal Reserve Bank of New York staff analyzed the "salient forces behind a dealer-intermediary's decision to move a bilateral repo transaction with a customer into central clearing."
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SIFMA argued that the SEC must take "urgent action" to resolve outstanding issues concerning the implementation of Treasury Central Clearing Rules.
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The SEC approved amendments to the Fixed Income Clearing Corporation's rules on central clearing for Treasuries. The amendments include "changes related to the separate calculation, collection and holding of margin for proprietary transactions of direct participants and indirect participant transactions."