What Is the Secured Overnight Financing Rate (SOFR)?

The secured overnight financing rate (SOFR) is a benchmark interest rate for dollar-denominated derivatives and loans that is replacing the London interbank offered rate (LIBOR). Interest rate swaps on more than $80 trillion in notional debt switched to the SOFR in October 2020. This transition is expected to increase long-term liquidity but also result in substantial short-term trading volatility in derivatives.

KEY TAKEAWAYS

The secured overnight financing rate (SOFR) is a benchmark interest rate for dollar-denominated derivatives and loans that is replacing the London interbank offered rate (LIBOR).

SOFR is based on transactions in the Treasury repurchase market and is seen as preferable to LIBOR since it is based on data from observable transactions rather than on estimated borrowing rates.

While SOFR is becoming the benchmark rate for dollar-denominated derivatives and loans, other countries have sought their own alternative rates, such as SONIA and EONIA.

Understanding the Secured Overnight Financing Rate (SOFR)

The secured overnight financing rate, or SOFR, is an influential interest rate that banks use to price U.S. dollar-denominated derivatives and loans. The daily secured overnight financing rate (SOFR) is based on transactions in the Treasury repurchase market, where investors offer banks overnight loans backed by their bond assets.

Benchmark rates such as the SOFR are essential in the trading of derivatives—particularly

interest-rate swaps, which corporations and other parties use to manage interest-rate risk and to speculate on changes in borrowing costs.