The Secured Overnight Financing Rate (SOFR) is a benchmark interest rate that reflects the cost of borrowing cash overnight collateralized by U.S. Treasury securities.

It is calculated by the Federal Reserve Bank of New York based on actual transactions in the Treasury repurchase market.

It was introduced in April 2018 as an alternative to the London Interbank Offered Rate (LIBOR) due to its transparency, robustness, and lower susceptibility to manipulation.

LIBOR has been criticized for being susceptible to manipulation, and it is being phased out in favor of rates like SOFR.

What is SOFR?

The Secured Overnight Financing Rate (SOFR) is a reference rate that measures the average interest rate banks pay to borrow money on an overnight basis from other banks using Treasury securities as collateral.

SOFR was developed by the Federal Reserve Bank of New York in collaboration with the U.S. Office of Financial Research in response to the LIBOR controversies, including rate-rigging scandals and concerns about the sustainability of the interbank lending market.

It is based on transactions in the U.S. Treasury repurchase agreement (repo) market, which involves short-term secured lending between financial institutions.

SOFR is seen as a more reliable and transparent benchmark rate than the London Interbank Offered Rate (LIBOR), which is based on estimates of what banks would charge each other for loans.

How does SOFR work?

SOFR is calculated daily using a volume-weighted median of transaction-level repo data.

This approach ensures that the rate represents a broad measure of overnight borrowing costs in the secured market.

Unlike LIBOR, which is based on expert opinions from a panel of banks, SOFR is derived from actual transaction data, making it more transparent and less susceptible to manipulation.

Why is SOFR important?

The transition from LIBOR to SOFR has gained momentum as regulators and market participants recognize the need for a more robust and transparent benchmark rate.

SOFR is now being used for various financial instruments, such as loans, mortgages, bonds, and derivatives.

Here are some of the advantages of SOFR:

  • It is based on actual transactions in the Treasury repurchase market, which makes it more reliable than LIBOR, which is based on estimates.
  • It is more transparent than LIBOR, as the data used to calculate it is publicly available.
  • It is more liquid than LIBOR, as there are more Treasury securities available to use as collateral.

Here are some of the disadvantages of SOFR:

  • It is a relatively new rate, and there is less historical data available than for LIBOR.
  • It is based on overnight transactions, so it may not be representative of longer-term interest rates.
  • It is not as widely used as LIBOR, so there may be less liquidity in SOFR-based products.

Who publishes the SOFR?

The Federal Reserve Bank of New York publishes SOFR daily, based on the previous day’s transactions in the U.S. Treasury repo market.

The data is available on their website, providing market participants with easy access to the latest information.