Secured Overnight Financing Rate (SOFR)

Secured Overnight Financing Rate (SOFR) is a benchmark interest rate used in the United States financial markets. It is an overnight rate based on secured transactions, specifically repurchase agreements (repos).

A repurchase agreement, or repo, is a transaction where one party sells a security (usually a bond or Treasury) to another party with an agreement to repurchase it at a later date. Repos are commonly used for short-term funding and liquidity management purposes.

SOFR was developed as a replacement for the London Interbank Offered Rate (LIBOR) in the United States. LIBOR, which is an interbank lending rate, has faced credibility issues and regulatory concerns. As a result, global regulators have been working to transition away from LIBOR and adopt alternative reference rates, such as SOFR.

SOFR is published by the New York Federal Reserve and endorsed by the U.S. Department of the Treasury and the Federal Reserve. It is calculated based on a broad set of overnight Treasury repurchase transactions. These transactions involve high-quality collateral and are considered to be secure and representative of the market.

SOFR is intended to be a more reliable and transparent benchmark rate compared to LIBOR. It reflects the cost of borrowing cash overnight, collateralized by U.S. Treasury securities. The rate is based on actual transactions and is determined by market forces, making it less susceptible to manipulation.

SOFR is widely used as a reference rate for financial contracts, derivatives, and other financial products. It is particularly relevant for futures contracts, interest rate swaps, and floating-rate notes. Many market participants have started transitioning their contracts from LIBOR to SOFR to align with the industry’s shift towards more robust and reliable reference rates.

The adoption of SOFR has been supported by regulatory authorities and industry organizations. However, the transition from LIBOR to SOFR is a complex process that requires market participants to update their systems, contracts, and risk management practices. Various industry-led initiatives and regulatory guidance have been introduced to facilitate a smooth transition.

Overall, SOFR aims to provide a more accurate and representative benchmark interest rate for the U.S. financial markets, enhancing market integrity and stability.