The Basics of SOFR
SOFR is expected to replace LIBOR at the end of 2021. Here are some quick facts for you to know.
November 30, 2020
Why is LIBOR going away, and when?
In July 2017, the UK Financial Conduct Authority (FCA) announced that it would no longer require banks to publish LIBOR past December 31, 2021, which means LIBOR may no longer be available or considered a reliable benchmark after this date. Subsequently, the Federal Reserve convened the Alternative Reference Rates Committee (ARRC), designed to address the LIBOR transition in the US. The ARRC identified the Secured Overnight Financing Rate (SOFR) as its preferred replacement to USD LIBOR.
What is SOFR?
SOFR (rhymes with gopher) stands for Secured Overnight Financing Rate, and is the presumptive replacement rate for USD LIBOR. Both the ARRC and ISDA have recommended SOFR as the replacement, which reflects actual transactions in the US overnight repo market.
How is SOFR different from LIBOR?
SOFR is transaction-based, whereas LIBOR relies on submissions by banks to be calculated. Since LIBOR is an administered rate, it is more susceptible to manipulation. SOFR, on the other hand, is calculated based on actual transactions that occur in the markets every day. SOFR is a secured (risk-free) overnight rate and LIBOR is an unsecured term rate. SOFR is typically lower than Libor and therefore requires the addition of a spread adjustment based on historical data to approximate LIBOR.
Who publishes SOFR, and how is it calculated?
The New York Fed publishes spot SOFR daily. It is calculated by taking the volume-weighted median of transactions for repurchase agreements that are collateralized by U.S. Treasuries. SOFR is an overnight, fully secured rate.
Because it is a daily rate, SOFR is inherently more volatile than LIBOR. There are different ways to calculate SOFR to reduce the volatility associated with a daily rate. For example, SOFR compounded in arrears is calculated by compounding daily SOFR and is determined at the end of the period.
Unlike with LIBOR, term SOFR does not yet exist. Term SOFR is a forward-looking rate (like 3-month LIBOR) that is determined by market expectations of future SOFR settings.
Where can I find additional information about SOFR rates?