(Bloomberg) -- The Federal Reserve Bank of New York is rolling out changes to a key benchmark tied to repurchase agreements next month aimed at ensuring the rate remains robust as the market for overnight lending shifts to more central clearing.
Beginning Nov. 25, calculation of the Secured Overnight Financing Rate, or SOFR, will be modified by removing transactions between affiliated institutions when relevant, while the influence of so-called “specials” transactions — repo trades that command a premium relative to the general collateral rate — will be adjusted to “eliminate day-to-day variability,” the New York Fed said in a statement Wednesday.
Both changes apply to transactions in the centrally cleared delivery-versus-payment (DVP) segment, the largest of the three market segments used to calculate SOFR, it said.
“The methodology change helps quell the fluctuations in volume associated with trimming the specials, so it gives a cleaner read on what day-to-day SOFR volumes are actually telling us,” said Deutsche Bank strategist Steven Zeng.
SOFR is calculated as a volume-weighted median of tri-party transactions in the repo market collected from BNY as well as General Collateral Finance. It also includes data on bilateral Treasury repo trades cleared through the Fixed Income Clearing Corp.’s DVP. The DVP data is currently filtered to exclude specials transactions below the 25th volume-weighted percentile rate.
Now the New York Fed’s change will remove a consistent 20% of the lowest-rate transactions from the centrally cleared DVP segment, with the aim to limit daily fluctuations.
The adjustments will also ensure the benchmark remains viable, especially in the wake of the US Securities and Exchange Commission’s push to make Treasury and repo markets more transparent and resilient to stress in the financial system. Treasury cash central clearing is expected to take effect by the end of 2025, followed by repo clearing on June 30, 2026.
At the end of 2023, the SEC finalized a rule requiring the migration of a large swath of Treasuries trading and almost all repo agreements linked to the government debt to a central counterparty clearinghouse, or CCP, to better secure the debt market. Clearinghouses are intermediaries between buyers and sellers in a trade and assume ultimate responsibility for completion of the transaction. This reduces the chance of default by one firm.
After the New York Fed released the proposal in July, Wall Street strategists, including Barclays Plc strategist Joseph Abate, deemed the proposed changes to the calculation methodology as necessary given how the repo market has evolved since the benchmark’s introduction in 2018.
And there’s a chance SOFR will continue to need modifications to keep up with the ever-evolving repo market, according to Gennadiy Goldberg, head of US interest rate strategy at TD Securities.
“It’s a living and breathing rate, so it’s certainly possible that the Fed chooses to make further modifications to make the rate more robust in the future,” Goldberg said.
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