However, Libor was marred by a series of scandals and concerns about inaccuracy due to manipulation. For example, mortgage holders with loans based on SOFR could see changes in their interest rates when their loan resets, depending on fluctuations in SOFR. Financial service providers use SOFR to price USD derivatives and loans.

• Financial market participants use SOFR to guide them in setting interest rates for certain types of loans.
• Along with the main rate, rates are published based on negotiated treasury prices in various percentiles – 25th, 75th, etc. – so that the rate may be higher or lower depending on what’s being used.
• For decades, the London interbank offered rate was the benchmark for pricing a wide variety of loans, including adjustable-rate mortgages.
• SOFR is used as a benchmark rate for other types of variable-rate loans, like private student loans, reverse mortgages, and home equity lines of credit (HELOCs).
• LIBOR was a popular benchmark rate based on what banks typically charged each other for short-term loans.
• Understanding these can provide valuable insights for market participants.

When two foreign counterparts engage in trade based on dollar lending/borrowing in the U.S., SOFR is relevant for Indian exporters or importers. A floating-rate trade finance loan based on SOFR or an interest rate swap referencing SOFR will impact trade financing costs. Moreover, the calculation of SOFR is not only important for financial institutions but also for policymakers and regulators. Understanding how SOFR is derived helps in assessing the overall health and stability of the financial markets, enabling informed decision-making and risk management strategies.

📆 Date: Aug 2-3, 2025🕛 Time: 8:30-11:30 AM EST📍 Venue: OnlineInstructor: Dheeraj Vaidya, CFA, FRM

• SOFR is an overnight rate, as in, it provides interest rates only for that limited time frame, while LIBOR is a benchmark that borrowers and lenders can use to calculate interest for up to 12 months.
• One significant benefit of using SOFR is its robustness and transparency.
• Most credit cards have a variable interest rate, but they tend to use the prime rate as a benchmark instead of SOFR.
• Financial authorities in the United States officially sunset LIBOR in June 2023.
• Understanding SOFR’s applications is crucial for finance professionals and institutions.
• It was found that the rate was indeed being manipulated, necessitating a replacement.

SOFR is also considered less risky than LIBOR, which the former replaced. SOFR is a volume-weighted median rate, calculated from a variety of repo transactions. Repos, or repurchase agreements, involve the sale and later repurchase of securities. Treasury securities, minimizes risk and differentiates SOFR from unsecured rates like LIBOR. SOFR’s calculation uses data from a broad spectrum of repo transactions, ensuring a comprehensive market representation.

SOFR in Financial Products

However, banks depend on a rolling average rate to ensure smooth daily volatility. Therefore, the average is calculated over a rolling period of 30, 90, or 180 days using the secured overnight financing rate history of the respective period. SOFR’s adoption as a benchmark rate has significantly influenced derivatives and other financial instruments. Derivatives like interest rate swaps, futures, and options play a central role in financial markets by providing tools for hedging and risk management. As SOFR gains prominence, it has been integrated into these instruments, offering a more stable basis for managing interest rate exposure. Big financial institutions lend money to each other using Treasury bond repurchase agreements, which financial pros call repos.

You may access the daily SOFR rate on the New York Fed’s website and other statistics, such as the SOFR Academy, which show averages over various periods. Major central banks globally have taken on similar reforms to replace their US LIBOR equivalents with more reliable rates. In the United States, SOFR has replaced LIBOR as the standard reference rate. Other countries use alternative financial benchmarks such as SONIA or ESTER. SOFR averages are measured by compounding rates over consecutive 30-, 90-, and 180-day intervals. This process mirrors the accrual of interest over these defined periods.

Data Sheets

The Secured Overnight Financing Rate (SOFR) is a standard interest rate measuring the cost of overnight borrowing cash collateralized by US Treasury assets. It is a more honest and open replacement for the London Interbank Offered Rate (LIBOR), which was tarnished by a manipulation controversy. In this article, we will investigate the value of SOFR in the financial markets, its origins, how it differs from LIBOR and how it is calculated. The Secured Overnight Financing Rate (SOFR) is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities. SOFR stands for secured overnight financing rate, which serves as a reference interest rate that helps financial experts price loans and other dollar-based financial products. It also serves as a benchmark replacement for the London Interbank Offered Rate (LIBOR), another standard rate.

It represents the benchmark interest rate for borrowing cash overnight with the U.S. It serves as an economic yardstick when setting rates for various financial products and currency swaps. The transition to SOFR from LIBOR brought about a huge change across the global More Money Than God financial landscape.

SOFR has become the preferred benchmark for pricing loans, aligning with efforts to establish a more transparent interest rate framework. SOFR was formed in response to the challenges generated by LIBOR manipulation. In 2017, the Alternative Reference Rates Committee (ARRC) suggested SOFR as the successor to the USD LIBOR. Unlike LIBOR, which involves term structure and credit risk, SOFR is an overnight rate with low risk as Treasury securities collateralize it. According to Patel, few consumers should notice any impact during the shift from Libor to SOFR.

Cash

Since the Federal Banks’ rates are to serve as savings instruments, a hike or lowering of the fed funds rate can also result in the upward or downward movement of SOFR. Since the loans under LIBOR are still in practice, comparing the two shows a stark difference in their liquidity rates. Since the Federal Reserve Bank of New York releases SOFR rates daily, it is an unexpressed certification of the credibility and genuineness of such rates. The NY Federal Reserve is, in fact, next in line with the top regulatory banks in the United States banking system. Other countries have their overnight rates, such as SONIA in Great Britain’s sterling market or the Euro Overnight Index Average (EONIA) in the EU.

Individual awards are made at the rates received by the Desk and awards are allocated in $1 million increments. Because LIBOR wasn’t based in any actual market movements, it was vulnerable to manipulation. Basically, the LIBOR rate was whatever the 17 institutions responsible for setting it said it was, regardless of whether market activity supported that rate. It was found that the rate was indeed being manipulated, necessitating a replacement.

Key Takeaways

It’s very lucrative for the regulators, less susceptible to market volatility, and secured by U.S. To understand simply, SOFR is like a ‘price tag’ for how much banks pay to borrow money from each other on a very short basis (overnight), using U.S. SOFR is a benchmark interest rate put in place by the Fed’s ARRC as a replacement for the defunct LIBOR index. It’s based on a weighted average of all the treasury repurchases that take place between banks in a given day. Because it’s based on actual negotiated transactions and not predictions, it doesn’t suffer from the same manipulation vulnerabilities of LIBOR.

These new products offer opportunities for market participants to diversify their portfolios and manage risks effectively in a changing interest rate environment. Furthermore, the ARRC has been actively involved in promoting the adoption of SOFR and providing guidance to market participants during the transition period. Their efforts have been instrumental in raising awareness about the importance of moving away from LIBOR and embracing alternative reference rates like SOFR. One of the key milestones in the development of SOFR was its official launch in April 2018. This marked a significant step towards the transition away from LIBOR and towards a more robust and reliable benchmark rate. Market participants gradually started adopting SOFR in various financial products and transactions, paving the way for its widespread use across the industry.

It was based on the average interest rate at which major global banks borrowed from one another, most notably using the three-month U.S. dollar LIBOR rate. However, LIBOR’s vulnerability became evident following the 2008 financial crisis. Regulators discovered that banks were manipulating LIBOR rates to their advantage, leading to major fines and global efforts to find more reliable alternatives. Unlike LIBOR, which was based on estimated borrowing rates between banks and exposed to manipulation, SOFR is based on observable transactions. This transparency addresses the shortcomings of LIBOR, making SOFR a more robust and dependable benchmark. The Secured Overnight Financing Rate (SOFR) has become an essential benchmark for global finance, especially in the US, affecting financial markets globally, even in India.

June 30, 2023 marked the retirement of LIBOR with the cessation of all LIBOR rates and the selection of SOFR as the new USD benchmark rate. With strict banking regulations coming into being after the financial crisis, there was a drastic reduction in interbank borrowing and trading which further impacted the reliability of LIBOR. With new rules that required banks to not share any interbank data after 2021, there was an increasing demand worldwide to identify an alternative rate.

In 2017, the Federal Reserve created the Alternative Reference Rates Committee (ARRC), which selected SOFR as the replacement for LIBOR. The Federal Reserve Bank of New York began publishing SOFR in April 2018 to help financial institutions transition away from LIBOR. Previously, people who opted for LIBOR-based car loans were required to pay interest rates in the LIBOR + X format. This 2.6% would typically increase if an applicant had a low credit score or several missed payments. With SOFR, a creditor may use the daily compounded interest or the SOFR index value to calculate the interest rate on a loan.