SOFR Rates Explained: What You Need to Know

The Secured Overnight Financing Rate (SOFR) is now the top interest rate for dollar-based derivatives and loans, replacing LIBOR¹. It comes from the Treasury repo market, showing real market conditions and borrowing costs¹. Unlike LIBOR, SOFR uses real transaction data, making it a stronger and clearer benchmark.

Switching from LIBOR to SOFR was a big job, done with help from regulators, banks, and market players². It was finished by June 2023, making SOFR the main rate for many financial products like derivatives, loans, and credit for consumers².

Key Takeaways

• SOFR is a benchmark interest rate based on actual transactions in the Treasury repo market, providing a more reliable and transparent alternative to LIBOR.
• SOFR has become the new standard for dollar-denominated derivatives and loans, replacing LIBOR by June 2023.
• SOFR is calculated by the New York Fed, with the rate published daily and average rates available for 30, 90, and 180-day periods.
• The transition to SOFR has faced some challenges, particularly in the derivatives market, but has been a coordinated effort involving regulators, financial institutions, and market participants.
• SOFR is viewed favorably by regulators for its robustness and availability, making it a suitable alternative to LIBOR for a wide range of financial products.

Introduction to SOFR

The Secured Overnight Financing Rate (SOFR) is a key interest rate that has become a top choice over the traditional U.S. dollar (USD) LIBOR³. It reflects the cost of borrowing overnight, secured by U.S. Treasury securities in the repo market. This market supports about $900 billion in daily transactions, making SOFR a solid and trustworthy benchmark³. In contrast, USD LIBOR is backed by less than $1 billion in daily transactions, making SOFR more reliable³.

What is the Secured Overnight Financing Rate (SOFR)?

SOFR is a benchmark interest rate chosen by the Alternative Reference Rates Committee (ARRC) in 2017 as a better option than USD LIBOR⁴. The move away from LIBOR came due to concerns over its unreliability and potential for manipulation, as well as a drop in interbank lending that supported the rate⁴. The New York Federal Reserve calculates SOFR, using actual borrowing costs from the Treasury repo market. This makes SOFR more transparent than LIBOR⁴.

History and Purpose of SOFR

The creation of SOFR was prompted by the LIBOR scandal in 2012, which showed how global banks manipulated LIBOR⁴. UK regulators then set a 2021 deadline for financial firms and investors to switch to alternative rates⁴. The LIBOR Act of 2022 made SOFR the official replacement for LIBOR in contracts without a plan for LIBOR’s end⁴. SOFR aims to be a more transparent and dependable benchmark, aiming to replace the troubled LIBOR³⁴⁵.

SOFR was created as an alternative to LIBOR, seen as vulnerable to manipulation⁴. The LIBOR Act of 2022 confirmed SOFR as the main replacement for LIBOR contracts, highlighting its key role in the shift from LIBOR to new benchmarks⁴.

“SOFR solves the rigging problem but may need to coexist with other rates.”
– Bank for International Settlements

SOFR as an Alternative to LIBOR

The Secured Overnight Financing Rate (SOFR) is now the top choice over the old London Interbank Offered Rate (LIBOR). This is because SOFR has a strong market base and clear borrowing costs⁶. It’s based on real overnight deals in the U.S. Treasury repo market, with over $1 trillion traded daily. This makes it more trustworthy and less open to manipulation than LIBOR⁷.

Switching from LIBOR to SOFR is a big job, with trillions of dollars’ worth of contracts needing to change by June 30, 2023⁶. The U.S. Federal Reserve set up the Alternative Reference Rate Committee (ARRC) to find a new rate. They picked SOFR in 2017 as the best alternative⁷. This change was to fix the fraud and manipulation problems with LIBOR, offering clearer borrowing costs⁶.

There were challenges in moving from LIBOR to SOFR. For example, figuring out a fair way to switch rates and needing “fallback clauses” in old loans tied to LIBOR⁶. Also, setting new loan prices under SOFR meant adjusting credit spreads to match the differences between LIBOR and SOFR base rates⁶.

Even though SOFR is the main U.S. dollar interest rate benchmark, other rates like Ameribor and Bloomberg Short-Term Bank Yield (BSBY) serve specific markets⁶. In the end, using SOFR marks a big move towards a more open and dependable system of interest rates⁶.

The move from LIBOR to SOFR is a key step in improving benchmark interest rates. It aims to build a stronger and clearer financial system⁶⁷⁸.

How SOFR Works

The Secured Overnight Financing Rate (SOFR) is a key interest rate widely used in finance⁹. It changes daily, based on the previous day’s repo market activity⁹. This makes it a crucial benchmark for financial markets⁹.

Underlying Market for SOFR

SOFR comes from the Treasury repurchase (repo) market. Here, a variety of financial institutions lend and borrow cash using U.S. Treasury securities as collateral¹⁰. It’s now the main interest-rate benchmark in the U.S. dollar, replacing LIBOR¹⁰.

Calculation Methodology of SOFR

The New York Fed uses a special method to calculate SOFR. It looks at the volume-weighted median of repo market transactions¹⁰. This ensures a fair and accurate view of overnight borrowing costs¹⁰.

SOFR is tied to the overnight cost of borrowing through U.S. Treasuries repurchase agreements¹⁰. The Federal Reserve Bank of New York publishes it daily at or near 8 a.m. Eastern time¹⁰.

Since January 2022, SOFR has replaced LIBOR for new loans in the U.S⁹.. It’s used by financial institutions to measure overnight borrowing costs⁹. SOFR shows if mortgage rates are going up or down⁹.

“SOFR is considered more reliable due to more than $1 trillion in daily transaction volumes underlying this rate, making it less prone to manipulation compared to LIBOR.”¹⁰

Characteristics of SOFR

The Secured Overnight Financing Rate (SOFR) is a strong and trustworthy benchmark interest rate. It’s seen as a better choice than the London Interbank Offered Rate (LIBOR), which faced scandals¹². SOFR’s strength comes from its large and varied market, with daily transactions near $1 trillion in 2020. This makes it the biggest rates market in the U.S¹²..

SOFR is calculated by averaging transaction data from a business day. This method makes it reliable and clear¹². Also, SOFR is shared on the Federal Reserve Bank of New York’s website around 8:00 a.m. ET the next day. This gives market players timely and checked data¹².

Transition from LIBOR to SOFR

Switching from LIBOR to SOFR is a big change for the financial world¹³. Since 2019, trillions of dollars in floating-rate notes linked to SOFR have been issued in the U.S¹³.. The Treasury repo market, SOFR’s base, sees over $1 trillion in daily deals. This shows the market’s size and liquidity¹³.

The move away from LIBOR, a key loan benchmark since the 1980s, is due to LIBOR’s manipulation issues¹³. The Federal Reserve backs SOFR as the new benchmark, expecting it to replace LIBOR by 2021¹⁴.

SOFR has shown it’s reliable and strong. But, the market will keep growing as more people use it¹⁴. Issues like index volatility and credit spread changes will need to be tackled. Alternative rates like AMERIBOR could also play a part, showing costs of unsecured overnight loans¹⁴.

sofr rates

The Secured Overnight Financing Rate (SOFR) is now a key interest rate, replacing LIBOR. It’s used for many financial tools¹⁵. As of June 1, 2023, the SOFR rate was 5.08%, reported by the Federal Reserve Bank of New York².

SOFR Averages give a clear view of SOFR rates over different time frames. By April 25, 2024, the rates were 5.33002% for the last 30 days, 5.34776% for 90 days, and 5.39029% for 180 days¹⁶.

SOFR is a strong and trustworthy benchmark. Its averages over the past 30 days have been between 5.32% and 5.35%. LIBOR fallback rates have been from 5.32644% to 5.35644%¹⁶.

The move from LIBOR to SOFR is a big step forward. It started with Fannie Mae’s first SOFR security in July 2018. Now, SOFR is becoming a key part of global finance¹⁶. As markets adjust, SOFR rates will be vital for secured overnight financing²¹⁵¹⁶.

Transition from LIBOR to SOFR

The shift from the London Interbank Offered Rate (LIBOR) to the Secured Overnight Financing Rate (SOFR) marked a big change in finance¹⁷. SOFR is now seen as a top choice over USD LIBOR. The Federal Reserve Bank of New York started publishing SOFR in April 2018¹⁸.

Timeline and Milestones

In 2017, the Alternative Reference Rates Committee (ARRC) picked SOFR as a new benchmark instead of USD LIBOR¹⁸. On November 30, 2020, the Federal Reserve said LIBOR would fade out. Banks were told to stop using LIBOR by the end of 2021¹⁸. By June 30, 2023, all LIBOR rates stopped, and SOFR took over as the benchmark for dollar contracts¹⁷.

This change was a worldwide effort. Countries like the UK, EU, Japan, Switzerland, and Canada moved to new rates like SONIA, ESTR, TONAR, SARON, and CORRA¹⁷.

The switch from LIBOR came from a need for stronger and more dependable benchmark interest rates¹⁸. LIBOR was in about $200 trillion of financial deals and securities¹⁷. The ICE Benchmark Administration (IBA) stopped publishing non-USD LIBOR rates and some USD LIBOR tenors in December 2021¹⁷. After June 2023, banks didn’t have to give info for USD LIBOR rates anymore¹⁷.

“The transition from LIBOR to SOFR is a significant event in the financial markets, as it marks the shift to a more robust and reliable benchmark interest rate.”

SOFR, with daily volumes of about $1 trillion, is a clear and data-focused alternative to LIBOR¹⁷. The switch to SOFR aims to make the financial system more stable and trustworthy¹⁷¹⁸.

Impact of SOFR Transition

The switch from the London Interbank Offered Rate (LIBOR) to the Secured Overnight Financing Rate (SOFR) is changing financial markets and products¹⁹. On June 30, 2023, US dollar Libor rates for one-, three-, six-, and 12-month terms stopped being published, marking a big change¹⁹. This change mainly affects the derivatives market and products like adjustable-rate mortgages and private student loans¹⁹. It also changes debt instruments such as commercial paper.

Companies working across borders and in different places need to understand interest rates like SONIA in the UK and EONIA in Europe for a smooth transition¹⁹. SOFR futures and swaps help manage interest rate risks based on SOFR¹⁹. New products like SOFR-linked floating rate notes (FRNs) and SOFR-indexed loans are being introduced as alternatives to old Libor-based products¹⁹.

SOFR is becoming more common in mortgages and deposits offered by banks¹⁹. Also, SOFR-linked swaptions and structured products like certificates of deposit and notes are being designed with SOFR as the reference rate¹⁹.

The move to SOFR is affecting the market for interest rate benchmarks²⁰. Over $1 trillion in daily transactions rely on SOFR, according to the U.S. Department of the Treasury²⁰. Most financial institutions have met the requirements to switch to new rates like SOFR²⁰. But, swaptions are still developing, while swaps have strong liquidity²⁰.

Switching from LIBOR to SOFR comes with challenges²¹. USD LIBOR is tied to about USD200tn of financial contracts and securities, with USD8.3tn related to securitisations²¹. When LIBOR stops in mid-2023, many will be affected, including corporate borrowers, end users of derivatives, investment banks, investors, consumers with loans tied to LIBOR, and credit card users²¹. Improving analytic libraries and operational capabilities is key to overcoming these challenges¹⁹.

SOFR and Financial Products

Derivatives and Cash Products

The Secured Overnight Financing Rate (SOFR) is now a key benchmark for many financial products. It’s used in interest rate swaps, where one side pays a fixed rate and the other pays a floating rate tied to SOFR¹.

SOFR is also popular in cash products like adjustable-rate mortgages and commercial paper. It’s involved in about $1 trillion in daily transactions, much more than other U.S. money market volumes¹.

About 2,000 institutions use the Treasury repo market, which is a big part of SOFR’s daily activity, around $1 trillion in 2020¹. Money market funds, with $4.5 trillion in assets, also touch the repo market, key for SOFR¹.

SOFR’s strong governance and methods mirror international standards, making it a trustworthy overnight Treasury repo market benchmark¹. The New York Fed has been publishing SOFR rates and averages since March 2020¹.

As the financial world moves from LIBOR to SOFR, it’s important to quickly adopt SOFR in financial contracts¹. This shift is urgent since LIBOR might end after 2021. Over 300 institutions and groups are working together to help with this change¹.

“SOFR has become a widely accepted alternative to LIBOR, with its robust governance and large underlying transaction volume making it a reliable benchmark for a broad range of financial products.”

SOFR Adoption by Market Participants

The Secured Overnight Financing Rate (SOFR) is becoming a key interest rate, thanks to the Alternative Reference Rates Committee (ARRC)²². The ARRC, formed in 2018, has led the move away from the USD London Interbank Offered Rate (LIBOR)²². In 2020, it shared clear steps for the market to follow²².

The ARRC includes banks, regulators, and private companies, making the switch to SOFR easier²². This teamwork has helped make the change global, with similar groups in other currencies²².

Many financial groups, like asset managers and banks, now use SOFR²². This move has made SOFR a top choice after USD LIBOR²².

For the latest on Risk-Free Rates (RFRs), including SOFR, check Tradeweb’s RFR Resource Center²³.

About 96 percent of new loans used SOFR by April 2022²⁴. The spread adjustments for old LIBOR loans vary, while new SOFR loans in 2022 have different spreads²⁴.

Financial markets need to switch from LIBOR to SOFR by next June to avoid issues²⁴. The Loan Syndications and Trading Association (LSTA) has a model agreement for Term SOFR widely used, and most LIBOR loans have fallback options for switching²⁴.

The US loan market’s support for Term SOFR has helped make the switch successful²⁴.

“Many market players, including asset managers and banks, have chosen SOFR, making it a strong and reliable interest rate.”

Challenges and Considerations

Switching from LIBOR to SOFR brings challenges for companies doing business across borders. Each region has its own alternative reference rate. For instance, SOFR is now the go-to for dollar contracts in the U.S. But, market players need to know the different rates used in other places to smoothly switch and keep their financial deals consistent²⁵.

Cross-border Transactions and Benchmark Alignment

Today’s finance world is global, making it hard to keep up with different benchmark interest rates. The UK uses SONIA instead of LIBOR, and Europe has chosen EONIA. It’s key for companies working across borders to match these rates to keep everything in line²⁵.

To tackle this, companies need to deeply understand each benchmark’s details. This includes its market dynamics, how it’s calculated, and the rules around it. Knowing this will help them adjust their financial deals and follow the law in each country²⁵.

By matching these rates and keeping a consistent approach, companies can lessen the risks linked to the LIBOR change²⁵.

“The move from LIBOR to SOFR is a complex process that needs careful planning and knowledge of the global benchmark rates. Companies must make sure they’re in sync with these rates to keep their financial deals solid.”

– Renee Kuhl, Managing Director for the Loan Agency Group at SRS Acquiom²⁵

SOFR Averages and Term Rates

The New York Fed publishes SOFR Averages for 30-day, 90-day, and 180-day periods, along with a SOFR Index²⁷. These averages help market players build SOFR-linked contracts²⁷.

Term SOFR Reference Rates from the CME Group are also available for one-month, three-month, and six-month periods²⁷. The CME is adding a 12-month rate soon²⁷. The ARRC picked the CME to manage a forward-looking SOFR term rate when market conditions are right²⁷.

Using SOFR in financial contracts is becoming more common, thanks to its use in futures, swaps, and floating-rate debt²⁷. SOFR Averages and CME’s Term SOFR Rates are available for different time periods²⁷. Both use Actual/360 days for calculations, a common method in US money markets²⁷.

If a benchmark rate is unavailable, interpolation can be used, depending on the situation²⁷. For periods not matching one, three, or six months, the next closest rate or interpolation is used²⁷.

“A resource titled ‘The Different SOFR Rates’ was put together last year to explain the various SOFR rates.”²⁸

The shift from LIBOR to SOFR is ongoing, offering more benchmark interest rates for new financial contracts.

Regulatory Landscape and SOFR

Financial regulators have pushed for a switch from LIBOR to SOFR. They’re concerned about LIBOR’s risk of being manipulated and its link to less lending between banks²⁹. The group that oversees LIBOR says it won’t provide the rate after 2021. They’re pushing for SOFR as the new standard for dollar deals³⁰.

The rules around switching from LIBOR to SOFR are changing fast³¹. A group called the Alternative Reference Rates Committee (ARRC) is leading the way to SOFR. They’ve made a plan to help markets switch to SOFR smoothly, covering things like derivatives and floating-rate notes³¹.

Groups like the Federal Reserve and the UK Financial Conduct Authority are giving guidance and setting deadlines for leaving LIBOR behind³¹. For instance, a law passed in March 2022 helped ease the move for $75 trillion in “tough legacy” loans³⁰.

As the finance world changes, everyone needs to adjust to new ways of pricing and dealing with SOFR²⁹. The rules around SOFR are still changing, aiming for a smooth shift away from LIBOR³¹.

Future Outlook for SOFR

The shift from LIBOR to SOFR is moving forward, and the outlook for this interest rate is bright. The Alternative Reference Rates Committee (ARRC) urges quick adoption of SOFR in financial contracts. They suggest using SOFR fallback language in new LIBOR contracts³². While some contracts might use a forward-looking SOFR term, most should switch to SOFR directly. This helps in creating a strong SOFR derivatives market, which is key for a smooth transition³³.

The ARRC is dedicated to fostering a dynamic market with reliable reference rates. These rates follow international standards and are ready for use before LIBOR’s end³³. In 2024, SOFR stayed steady at 5.31 percent, and daily repo transactions hit over $1.5 trillion³³. The Fed’s Overnight Reverse Repo (ON RRP) facility has set a low rate since 2013³³. The Standing Repo Facility (SRF) has a higher rate at the top of the target range³³. By May 2024, only 36 participants were in SRF deals, and most repo rates were below the SRF since 2021³³.

Reductions in the Fed’s balance sheet have made less funds available for SOFR, pushing its rate up slightly within the target range³³. But, the Fed has slowed down its tightening, which might halt the SOFR increase soon³³. Overall, the outlook for SOFR is strong, thanks to the ARRC’s support for a robust market.

“The ARRC remains committed to supporting a vibrant and innovative market with reference rates that are robust, consistent with international best practices, and available for use before the end of the LIBOR transition period.”

Conclusion

The move from LIBOR to SOFR has changed the financial world. SOFR is now the top choice for dollar-based derivatives and loans. It’s based on a wide, diverse market and follows international standards, making it a better choice than LIBOR³⁴.

Many big names in finance and government agencies have started using SOFR. This has helped make it the new standard for U.S. dollar financial products³⁴. As the switch continues, there are challenges like handling cross-border deals and new reference rates. But, SOFR’s clear and strong nature offers big advantages.

The shift from LIBOR to SOFR has had its ups and downs. Yet, the finance world’s effort to switch shows how crucial a stable and clear benchmark is for the global economy. With SOFR becoming more popular, it’s set to be key in a safer, more efficient financial world. This marks the start of a new era for benchmark interest rates³⁵.

Source Links

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4. SOFR
5. SOFR: The Secured Overnight Financing Rate
6. Differences Between LIBOR and SOFR
7. – Alternative Reference Rates Committee
8. LIBOR to SOFR Transition: What You Need to Know
9. What is SOFR (Secured Overnight Financing Rate)? | Chase
10. Secured Overnight Financing Rate (SOFR), Defined And Explained
11. What Is SOFR And How Does It Work? | Quicken Loans
12. PDF
13. Secured Overnight Financing Rate (SOFR)
14. SOFR: Key Characteristics & Hedge Accounting Impacts
15. 10-Year Swap Rates, Treasuries, Fallback Rate (SOFR), SOFR, Term SOFR
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18. PowerPoint Presentation
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20. Exploring 3 Major Challenges of the SOFR Transition
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22. PDF
23. Measuring the Market Transition from LIBOR
24. SOFR transition progresses despite volatile markets | White & Case LLP
25. SOFR Today: Credit-Spread Adjustments (CSA)
26. Considerations for a Transition to SOFR and other Alternative Rates – SECOR Asset Management
27. PDF
28. Term SOFR vs Daily Simple SOFR – What’s the Difference?
29. Lenders, LIBOR, and the move to the risk-free SOFR rate: seven takeaways for financial services firms
30. SOFR Today | Credit Spend Adjustments | Rising Interest Rate
31. LIBOR is Dead. Long Live SOFR – The Global Treasurer
32. Life After LIBOR: A Comprehensive Financial Outlook
33. SOFR, so good? The outlook for the ‘world’s most important number’
34. What is SOFR, and Why is it Replacing LIBOR? – Penserra
35. What is SOFR? Secured Overnight Financing Rate | Rate

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