SOFR

Secured Overnight Financing Rate (SOFR) is a secured overnight interest rate. SOFR is a reference rate
(that is, a rate used by parties in commercial contracts that is outside their direct control) established as an
alternative to LIBOR. LIBOR has been published in a number of currencies and underpins financial
contracts all over the world. Because LIBOR is derived from banks' daily quotes of borrowing costs, banks
were able to manipulate the rates through lying in the surveys.[1] Deeming it prone to manipulation, UK
regulators decided to discontinue LIBOR in 2021.[1]

In 2022, the LIBOR Act passed by the U.S. Congress established SOFR as a default replacement rate for
LIBOR contracts that lack mechanisms to deal with LIBOR's cessation.[2] The Act also grants a safe
harbor to LIBOR contracts that transition to SOFR.[2] Previously, SOFR was seen as the likely successor
of LIBOR in the US since at least 2021.[1]

SOFR uses actual costs of transactions in the overnight repo market, calculated by the New York Federal
Reserve.[1] With US government bonds serving as collateral for borrowing, SOFR is calculated differently
from LIBOR and is considered a less risky rate.[1] The less risky nature of SOFR may result in lower
borrowing costs for companies.[1] In addition, unlike the forward-looking LIBOR (which can be calculated
for 3, 6 or 12 months into the future), SOFR is calculated based on past transactions, which limits the rate's
predictive value on future interest rates.[1] In addition, SOFR is overnight, whereas LIBOR can have
longer tenors.

History
In 2012, it was revealed that banks around the world had manipulated the London interbank offered rate
(LIBOR). In the aftermath of the scandal, global regulators decided to move away from the LIBOR, a vital
part of the financial system given that it’s linked to around $300 trillion of loans, derivatives and other
instruments across various currencies.[3] It also didn’t help that volumes underlying the benchmark dried
up. U.K. regulators set the deadline at 2021 for financial firms and investors to transition away from the
Libor.[3]

In June 2017, US Federal Reserve Bank's Alternative Reference Rates Committee selected what's called
the Secured Overnight Financing Rate, or SOFR as the preferred alternative to Libor.[4] The committee has
noted the stability of the repurchase market on which the rate is based.[5] The New York Federal Reserve
began publication of the rate in April 2018.[5]

In August 2018, Barclays became the first bank to issue commercial paper tied to the rate; selling some US
$525 million of short-term debt.[6] Previously, Fannie Mae issued $6 billion securities tied to SOFR in July
2018. Again in October 2018, Fannie Mae issued a second $ 5 billion securities that was also similarly tied
to SOFR.[7]

In July 2019, the SEC and the President of the New York Federal Reserve John Williams called on banks
to swiftly transition from Libor to its replacements, such as SOFR, instead of waiting until the 2021
deadline.[3] If a smooth transition from Libor cannot take place, smaller banks may reduce lending and
companies may be less capable of hedging interest rate risks.[8] Public dollar bonds linked to the SOFR
were sold by the Bank of China (in October 2019), the World Bank (in February 2021) and by the Korea
Development Bank (in March 2021).[9]
Companies are required to transition away from LIBOR on new contracts after Dec. 31, 2021, and for
legacy contracts after June 30, 2023.[1][9]

LIBOR Act (2022)

On March 15, 2022, U.S. President Joe Biden signed the Adjustable Interest Rate (LIBOR) Act.[2] The
LIBOR Act will transition certain contracts that lack mechanisms to deal with the cessation of LIBOR,
replacing LIBOR with SOFR in such contracts, effective July 1, 2023.[2] The federal LIBOR Act is similar
to prior legislation passed in New York State in 2021, but is broader as it applies across the United States,
not just contracts under New York law.[10][11]

As different versions of SOFR exist, such as Term SOFR and compounded SOFR, the LIBOR Act
requires the Federal Reserve to issue a regulation by September 2022, to identify which version of SOFR
will apply to contracts subject to the legislation.[2] As LIBOR is based on unsecured loans made to banks,
whereas SOFR is a loan secured by Treasuries, the Federal Reserve is required to add spread adjustments
to SOFR (one for each tenor of LIBOR) to account for the difference in credit-risk between the rates.[2]

The Act is seen as an important milestone in the transition away from LIBOR.[2] However, the Act has
important limitations. For example, it generally only applies to contracts that lack a non-LIBOR
replacement rate, so if another rate is already selected, like the Prime Rate, or Fed Funds rate, then the Act
would not apply.[2]

Technical features
SOFR is based on the Treasury repurchase market (repo), Treasuries loaned or borrowed overnight.[5]
SOFR uses data from overnight Treasury repo activity to calculate a rate published at approximately 8:00
a.m. New York time on the next business day by the US Federal Reserve Bank of New York.[12]

Unlike Libor, SOFR uses banks' actual borrowing costs rather than unverifiable estimates submitted by a
panel of banks.[8] However, it may still be vulnerable to manipulation. Banks can borrow and lend at
biased rates in the wholesale funding market, which can lead them to profit in the much larger market for
benchmark-indexed contracts.[8] It was therefore suggested that the lending costs of individual banks be
published to increase transparency and deter manipulation.[8]

The Bank for International Settlements, which serves as the bank for central banks, said in March 2019 that
a one-size-fits-all alternative may be neither feasible nor desirable. Although SOFR solves the rigging
problem, it does not help participants gauge how stressed global funding markets are. That means SOFR is
likely to coexist with something else.[13]

See also
AMERIBOR

References
1. Trentmann, Nina (2020-12-30). "Finance Executives Look to Advance Libor Transition in
2021" (https://www.wsj.com/articles/finance-executives-look-to-advance-libor-transition-in-2
021-11609338601). Wall Street Journal. ISSN 0099-9660 (https://www.worldcat.org/issn/009
9-9660). Retrieved 2021-01-24.
 2. Stromfeld, Lary; Halper, Jason; Rodman, Rachel; Stromfeld, Lary; Halper, Jason; Rodman,
Rachel (2022-03-23). "Federal LIBOR legislation: five things financial market participants
need to know" (https://www.reuters.com/legal/transactional/federal-libor-legislation-five-thing
s-financial-market-participants-need-know-2022-03-23/). Reuters. Retrieved 2022-03-26.
3. "Regulators call for urgent move away from Libor" (https://www.reuters.com/article/us-usa-fe
d-williams-idUSKCN1UA1DW). Reuters. 2019-07-15. Retrieved 2020-08-20.
4. "LIBOR: Where Things Now Stand; Insight #124" (https://www.bakermckenzie.com/en/insigh
t/publications/2017/11/libor-where-things-now-stand). Baker McKenzie.
5. "What is SOFR? The new U.S. Libor alternative" (https://www.reuters.com/article/us-usa-bon
ds-sofr-explainer-idUSKCN1HA0H1). Reuters. April 3, 2018.
6. Tempkin, Adam; McCormick, Liz (August 27, 2018). "Libor Challenger Embraced in Debut
Commercial Paper Transaction" (https://www.bloomberg.com/news/articles/2018-08-27/libor
-challenger-embraced-in-debut-commercial-paper-transaction). Bloomberg Businessweek.
7. "SOFR - Fannie Mae Continues to Lead the Secured Overnight Financing Rate (SOFR)
Market with Second Issuance of $5B" (https://www.fanniemae.com/portal/media/financial-ne
ws/2018/sofr-security-debt-market-issuance-6779.html). Fannie Mae.
8. Troege, Michael (2020-08-04). "Libor and Euribor replacements are also vulnerable" (https://
www.ft.com/content/36c63998-5ead-4469-bf94-ccf3c3a335ad). FT. Retrieved 2020-08-20.
9. Davis, Morgan (March 9, 2021). "Asia DCM: Sofr transition needs free push" (https://www.glo
balcapital.com/article/b1qwhgkjd4vk2h/asia-dcm-sofr-transition-needs-fresh-push).
10. "New York's Legacy LIBOR Legislation: A User's Guide to Fall Back On" (https://www.sidley.
com/en/insights/newsupdates/2021/04/new-yorks-legacy-libor-legislation). www.sidley.com.
Retrieved 2022-03-26.
11. "Congress passes LIBOR legislation" (https://www.davispolk.com/insights/client-update/con
gress-passes-libor-legislation). Davis Polk. Retrieved 2022-03-26.
12. "What is SOFR?" (https://www.cmegroup.com/education/files/what-is-sofr.pdf) (PDF). CME
Group. March 2018. Retrieved 2019-01-10.
13. "Putting Libor Out of Its Misery Is Proving Easier Said Than Done" (https://www.bloomberg.c
om/news/articles/2019-04-03/putting-libor-out-of-its-misery-is-proving-easier-said-than-don
e). Bloomberg. April 2019. Retrieved 2019-10-27.

External links
"Secured Overnight Financing Rate" (https://apps.newyorkfed.org/markets/autorates/sofr).
Federal Reserve Bank of New York.
"A User's Guide to SOFR" (https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/201
9/Users_Guide_to_SOFR.pdf) (PDF). The Alternative Reference Rates Committee. April
2019. Retrieved 2019-05-06.

Retrieved from "https://en.wikipedia.org/w/index.php?title=SOFR&oldid=1162724754"