The final stretch: outstanding issues in non-linear RFR derivatives

Six months on from Libor’s cessation, cash and derivatives markets have adapted quickly to the new multi-rate world. In the US, where selected US dollar Libor tenors will remain in place until mid-2023, the secured overnight financing rate (SOFR) is firmly established as the preferred alternative for derivatives.

However, one area of the market remains resistant to change: non-linear derivatives – such as options, caps and floors – are poorly suited to backward-looking benchmarks such as SOFR, and market participants face difficult questions around product structure, volatility, valuation, pricing, liquidity and hedging.

Key topics discussed:

• How the market is adapting to SOFR swaptions
• The products best suited to SOFR
• Lessons from the latest deals and developments
• The current state of the market: volumes and liquidity in risk-free rate options, caps and floors, and other complex products
• Valuation and pricing hurdles associated with in-arrears rates
• Challenges and developments in modelling volatility in SOFR and overnight rates.