SOFR (Secured Overnight Financing Rate)

The Secured Overnight Financing Rate (SOFR) is a broad measure of the cost of borrowing US dollars overnight using US Treasury securities as collateral. It is calculated from actual transactions in the Treasury repurchase agreement (repo) market and published each business day by the Federal Reserve Bank of New York. It has since taken the place of US dollar LIBOR as the principal benchmark for pricing dollar-denominated loans, bonds and derivatives.

Because it is based on secured lending, SOFR reflects an almost risk-free rate rather than the credit risk of banks. That makes it structurally different from LIBOR, which was an unsecured rate based in large part on bank submissions.

After investigations from 2012 onward revealed manipulation of LIBOR by banks, regulators sought benchmarks anchored in real transactions. In the United States, the Federal Reserve convened the Alternative Reference Rates Committee (ARRC), which in 2017 selected SOFR as its recommended alternative to US dollar LIBOR. The New York Fed began publishing SOFR in April 2018, in cooperation with the Office of Financial Research. US dollar LIBOR panel publication ended on June 30, 2023, and the temporary synthetic version ended in September 2024. The Adjustable Interest Rate (LIBOR) Act of 2022 provided a statutory replacement, based on SOFR, for legacy contracts that lacked workable fallback language.

SOFR is a volume-weighted median of overnight Treasury repo transactions drawn from three segments: tri-party repo, General Collateral Finance (GCF) repo, and bilateral Treasury repo cleared through the Fixed Income Clearing Corporation. The rate for each business day is published at approximately 8:00 a.m. Eastern time on the following business day. Daily volumes underlying the rate are very large, often well above US$1 trillion, which makes the benchmark difficult to manipulate.

SOFR typically trades close to, but not identical with, the federal funds rate, the unsecured overnight rate between banks that the Federal Reserve targets. It can spike at quarter-ends or when Treasury collateral and cash are unevenly distributed, as happened in September 2019.

Because SOFR is an overnight rate, contracts with longer interest periods need a way to convert it into a term rate:

• Compounded in arrears: daily SOFR values are compounded over the interest period, so the final payment is known only near the period's end. This method is standard in interest rate swaps.
• SOFR averages and index: the New York Fed publishes 30-, 90- and 180-day compounded averages and a SOFR Index to simplify calculations.
• Term SOFR: forward-looking one-, three-, six- and twelve-month rates derived from SOFR futures, administered by CME Group and widely used in business loans.

When legacy LIBOR contracts moved to SOFR, a fixed credit spread adjustment was added to reflect the historical difference between the two rates; for three-month LIBOR in derivatives, the ISDA fallback spread was about 26 basis points.

A company borrows US$10 million at three-month Term SOFR plus 2.00 percent. If Term SOFR is set at 4.30 percent for the period, the all-in annual rate is 6.30 percent. For a 90-day period on an actual/360 basis, interest is US$10,000,000 × 6.30% × 90/360, or US$157,500. If the company has hedged with an interest rate swap on a notional amount of US$10 million, it pays a fixed rate and receives compounded SOFR, offsetting changes in the floating part of the loan.

Critics, particularly regional and mid-sized banks, noted that SOFR contains no credit component, so it can fall during periods of stress when banks' own funding costs rise, squeezing lenders' margins. Alternatives such as the credit-sensitive rate AMERIBOR were proposed, but SOFR became the dominant benchmark for derivatives, floating-rate notes and most new loans. Other currencies adopted their own risk-free rates, such as SONIA in sterling and €STR in euro, which sometimes complicates cross-currency structures and the measurement of the cross-currency basis. SOFR also feeds into the pricing of money market funds and short-term instruments such as Treasury bills, and it forms the short end of the dollar yield curve used in valuation. For the US central bank, see the Federal Reserve regulator profile.

• SOFR at the Federal Reserve Bank of New York