The Alternative Reference Rates Commission (ARRC), formed by the Federal Reserve Board and the Federal Reserve Bank of New York, identified the Secured Overnight Financing Rate (SOFR) as an alternative reference rate to replace LIBOR.
The ARRC and the Federal Reserve Bank of New York believe that SOFR is the most appropriate rate for widespread and long-term adoption because it is based on observable, objective, and transparent interest rate transactions. However, banks are considering additional options for use in the U.S.
SOFR is based on overnight transactions in the U.S. dollar Treasury repurchase market (repo). It is the largest rates market at a given maturity in the world, averaging roughly $1 trillion of transactions every day.1
Why is SOFR different?
SOFR has several characteristics that make it distinct and different from LIBOR and other floating rate indices. Specifically, SOFR is:2
- A secured rate represented by transactions within the U.S. Treasury repo market.
- Based on markets that the ARRC believes have sufficient depth and are active enough to be reliably produced in a wide range of market conditions.
- Produced by the Federal Reserve Bank of New York.
SOFR vs. LIBOR: Key Differences
|Daily average of what banks say they would have to pay to borrow from another bank over a given term (i.e., one-month and three-month).||Index based solely on actual overnight transactions collateralized by Treasuries. There is currently no term structure associated with the SOFR rate.|
|Inherently forward looking; borrower knows at the beginning of the period what the interest rate will be over the term.||Backward looking because it uses transactions from the previous night; rate changes daily.|
|Bank-to-bank lending is unsecured; includes a small credit risk premium/spread.||Transactions are secured by Treasuries; lacks a credit risk premium/spread.|
SOFR vs. LIBOR Rate Comparisons
SOFR is published daily by the Federal Reserve Bank of New York and may be more volatile than the one-month LIBOR. However, over time SOFR is reasonably comparable to short-term LIBOR indices. The gap between LIBOR and SOFR is primarily made up by a credit risk premium spread.3
1-month LIBOR vs daily SOFR
1-month LIBOR vs 1-month compounded SOFR
Source: Pensford, "LIBOR vs. SOFR"
How SOFR Is Calculated
SOFR includes all trades in the Broad General Collateral Rate, plus bilateral Treasury repurchase agreement transactions cleared through the Delivery-versus-Payment (DVP) service. The DVP is offered by the Fixed Income Clearing Corporation (FICC), which is filtered to remove a portion of transactions considered “specials,” that are repurchases for specific-issue collateral.4
SOFR is calculated as a volume-weighted median of transaction level data observed over the course of a business day and is published on the Federal Reserve Bank of New York website at approximately 8:00 a.m. ET on the next business day. The SOFR published on any given day represents the rate repurchase transactions entered into on the previous day. The date associated with each rate reflects the date of the underlying transactions rather than the date of publication.5
Visit the Alternate Reference Rates website for more detailed information about SOFR and how it is calculated.