In November 2014, the U.S. Federal Reserve convened the Alternative Reference Rate Committee (ARRC.)

The ARRC’s objective was to identify a set of alternative reference interest rates firmly based on transactions from a robust underlying market that comply with the International Organization of Securities Commissions (IOSCO) Principles for Financial Benchmarks and to identify an adoption plan to facilitate the acceptance and use of the chosen rate.

On June 22, 2017, the ARRC announced its preferred alternative reference rate: the Secured Overnight Financing Rate (SOFR).

The SOFR was designed and implemented by the Federal Reserve Bank of New York (FRBNY) and the U.S. Treasury Office of Financial Research (OFR), in close consultation with the ARRC.

The SOFR reflects a broad universe of overnight U.S. Treasury repo transaction activity, making it a benchmark for all seasons, regardless of future shifts in market preferences for bilateral versus tri-party repo.

The SOFR is based upon a massive, diverse and fully transaction-based data set, drawn from three sources, with aggregate average daily volume of $808 billion based on third quarter 2017 data.

Those sources are:

Tri-party Treasury repo transactions cleared and settled by Bank of New York Mellon (BNYM), excluding General Collateral Financing (GCF) Repo and transactions in which the Federal Reserve is a counterparty.

Treasury repo transactions occurring within the Depository Trust & Clearing Corporation’s (DTCC) GCF service that the Fixed Income Clearing Corporation (FICC) acts as a central counterparty.

Bilateral Treasury repo transactions cleared through FICC’s Delivery-versus-Payment (DVP) service.

On any given day, prior to pooling transaction data from these three sources, the FRBNY will rank the day’s FICC DVP bilateral repo transaction volumes by their transaction rates, from lowest to highest, and will then filter out 25% of trading volume corresponding to the lowest transaction rates. The object of such filtering is to remove repo transactions in which Treasury collateral is likeliest to be trading special, to achieve a residual set of bilateral repo data that largely reflects general collateral transactions.

After filtering the FICC DVP bilateral repo transaction data, the FRBNY will pool the data from the three sources, rank all repo transaction volumes by their transaction rates, from lowest to highest, and then compute the transaction-weighted median repo rate, i.e., the repo trade rate for which half of the day’s repo transaction volume is made at transaction rates that are equal to it or greater than it. The transaction-weighted median repo rate becomes the day’s SOFR benchmark value.

The SOFR will be published for each U.S. government securities market business day at least as early as 8:00 a.m. Easter Time (ET) on the next U.S. government securities market business day. The SOFR will be published by the FRBNY in cooperation with the OFR.

Exhibit 2 displays daily SOFR and EFFR values during (August 22, 2014 through October 17, 2017).

The daily SOFR shows broad similarity to the daily EFFR, which is the underlying reference for CME Group’s 30-Day Federal Fund futures. On average, daily SOFR is 3.9 basis points lower than daily EFFR.

However, daily SOFR is more volatile than daily EFFR, particularly around quarter-end dates. A conspicuous example is the last week of September 2016, when SOFR doubled from about 45 to 90 basis points. The increased volatility relative to EFFR is generally attributable to banks’ balance sheet adjustments at quarter-end, which lead them to be temporarily less active in the Treasury repo markets that underpin SOFR.

Exhibit 2

Daily SOFR and EFFR Values (Basis Points per Annum),

22 Aug 2014 through 17 Oct 2017