What is Sofr?
The secured overnight financing rate (Sofr) is a new lending
reference rate established by the Federal Reserve Bank of New
York. It sets the benchmark interest rate of the cost of
borrowing cash overnight as collateralised by US Treasury
securities. Although still in its infancy, US regulators
anticipate that the rate will be widely adopted to back the
derivatives and loans market, and is widely expected to be the
universally accepted replacement for the outgoing London
interbank offered rate (Libor), which expires at the end of
How is the rate calculated?
The way Sofr is calculated incorporates all of the trades in
the Broad General Collateral Rate (BGRC), another rate that
measures overnight Treasury collateral transactions, as well as
bilateral Treasury repurchase agreement (repo) transactions
that are cleared through the delivery-versus-payment (DVP)
service offered by the Fixed Income Clearing Corporation
"It transpired during the
financial crisis that multiple banks had been
manipulating the Libor price for several years, which
led to hefty fines, multiple court cases and
imprisonment for UBS trader Tom Hayes"
The New York Fed’s website
states that Sofr is calculated as a volume-weighted median
of transaction-level tri-party repo data collected from the
Bank of New York Mellon as well as GCF Repo transaction data
and data on bilateral Treasury repo transactions cleared
through FICC's DVP service, which are obtained from DTCC
Solutions, an affiliate of the Depository Trust & Clearing
This is the rate that banks will pay on the repo market for
borrowing overnight. The New York Fed publishes the Sofr rate
on its website at around 8am every morning.
Who came up with this?
The rate was established by the Alternative Reference Rate
Committee (ARRC), which was appointed by the Board of Governors
of the Federal Reserve System and the Federal Reserve Bank of
New York in 2014, in response to growing concerns that existing
rates were insufficient for the needs of the market.
ARCC was tasked with identifying best practices for
alternative reference rates, like Sofr, as well as finding best
practices for contract robustness, developing adoption and
implementation plans that include metrics of success.
The ARCC published its Paced Transition Plan as part of its
second report in March 2018. The plan addressed the
specific challenges that the transition to Sofr will pose, the
first of which is in establishing sufficient liquidity for
derivatives contracts that use the rate – as traders
will not be able to, or be expected, to make the transition
"The ARRC’s Paced Transition Plan is intended
to progressively build the liquidity required to support the
issuance of and transition to contracts referencing Sofr, and
to create conditions in which a robust term reference rate
based on derivatives referencing Sofr could be constructed and
itself used in some cash products," reads the report.
What's wrong with Libor?
The Libor rate is the existing rate that is widely used
around the world. It is an average of the interest rates that
London’s leading banks would be charged if they
were to borrow from other institutions. Currently it stands as
the first port of call for calculating interest rates, offering
overnight maturities as well as terms of one week and one, two,
three, six and 12 months. It is calculated in five currencies.
There are a number of reasons for the market shift away from
Libor. A scarcity in actual underlying transactions has meant
that the market needed to find an alternative. On top of this,
it transpired during the financial crisis that multiple banks
had been manipulating the Libor price for several years, which
led to hefty fines, multiple court cases and imprisonment for
UBS trader Tom Hayes.
This was followed by altercations in how the rate was set,
but the damage had been done and banks began to distance
themselves from the rate and contributed submissions less
often. The UK Financial Conduct Authority (FCA) announced plans
to phase out the rate by the end of 2021 and banks will no
longer be required to submit daily dates used in its
calculation, which may result in its demise.
JP Morgan Chase’s chief regulatory affairs and
chair of the Federal Reserve Board Alternative Reference Rates
Committee officer Sandie O’Connor told the PwC and
the Securities Industry and Financial Markets
Association’s (Sifma) Libor symposium in June that
the existing Libor rate is no longer fit for purpose, and the
industry must prepare for its eventual decline and formulate
durable fall-back language.
"If you think about financial benchmarks, not just Libor,
but any financial benchmarks, they are fundamental to
functioning markets," she said. "It is essential that they
maintain integrity so that instruments and products around the
globe can have a common linkage."
Libor does not meet the criteria that an adequate benchmark
must: transaction based and transparent with appropriate levels
of governance. The reference rate no longer has a high level of
transactions, averaging just $1 billion of trades per a day,
with that number often closer to $500 million. By way of
comparison, the entire market is estimated to be worth in the
region of $200 trillion.
"Some $750 billion in daily
volume makes Sofr the deepest, highest volume rates
market in the world, bar none. A true benchmark
didn’t exist until April 3"
This is an enormous inverted triangle of activity, meaning
that Libor is based on hypothetical transactions or judgement,
an awful lot of activity tied to a very small number of actual
"Sofr is the most critical deliverable of ARCC 1.0. We all
talk about why we have got to be prepared for when Libor ends,
but think about the Soft rate, on average it is $750 billion of
daily volume, a lot more than $1 billion," said
"Some $750 billion in daily volume makes Sofr the deepest,
highest volume rates market in the world, bar none. A true
benchmark didn’t exist until April 3. It is not
just that we are going away from something, we are going
towards something that is really good."
What are Sofr futures?
As the end of Libor approaches, one of the challenges is to
find a rate that is not Libor but in fact is based upon a much
larger volume of market transactions that can be said to really
affect market rates. This would be a rate not just based on
judgement. There are alternatives, like the Bank of England
backed Sonia rate, but Sofr is the frontrunner.
"The dynamic and the fundamentals look good," said
O’Connor. "But one sector or segment cannot do
this alone, we all have a collective interest - because we are
trying to prepare a new market for the eventuality of the
ongoing decline of Libor - so our organisations need to be
moving forward to implement and begin referencing
In June, Chicago-based derivatives and futures exchange CME
launched Sofr futures as part of the transition away from
"The evolution of a liquid futures market is an important
milestone of the ARRC paced transition plan. Clients have
indicated that Sofr futures will have immediate investing, risk
management, and hedging applications for repo and relative
value traders," Agha Mirza, managing director, interest rate
products at CME Group told IFLR.
Over 7,000 CME Sofr futures contracts traded in the first
week (listed May 7), and there are quarterly and seven monthly
contracts. The quarterlies will help provide building blocks
for the IRS market, whereas the monthlies offer greater
granularity at the front end of the curve, especially as the
nearest quarterly contract becomes more set through its
The liquidity generated in Globex through inter-commodity
spreads and implied pricing functionality has the potential to
combine with these initial applications to create a deep and
liquid Sofr derivatives market over time that may have wider
interest rate benchmark applications, added Mirza.
Introducing futures is a solution to how Sofr overnight
secured rates can be evolved into something that would be more
useful for the existing markets that rely upon term periods in
"The goal is to take an overnight rate and turn it into term
periods. For example, if the overnight Sofr rate is x, what
would the rate be if you were talking about a 3-month Sofr
rate? That is something that is best determined again through
trading activity," said
Lary Stromfeld, partner at Cadwalader. "You need a futures
market that can determine what the market believes a 3-month
Sofr rate would be relative to the overnight rate, and that is
what this is."
"It begins to address one of the structural elements that
needs to develop to make the secured overnight rate into
something that is more of a term period," he added.
What are Sofr securities?
Additionally, in summer 2018 there have been several
issuances of Sofr backed securities, also instruments created
to help develop the market. Three bonds linked to the index
have launched so far. The first, a $6 billion floating rate
note July 26 issuance by Fannie Mae, which broke ground amid
hope that it would encourage a broader acceptance of securities
indexed to Sofr. It was swiftly followed by issuances from the
World Bank and Credit Suisse.
A spokesperson for Fannie Mae told IFLR that investors
and dealers have already expedited operational readiness for
"The issuance helped to demonstrate market interest in Sofr
based debt instruments. As a result, there are already
illustrations of the transaction accelerating the development
of the Sofr market, including: on July 30, Standard and
Poor’s recognised Sofr as an anchor money market
reference rate, which helps rated money market funds invest in
Sofr based instruments."
From a market development point, the more investors and
issuers involved in this market, the more traction Sofr gets.
As the market gains traction, and the more investors that are
set up to transact in Sofr-linked products, the better for the
development of the market.
"It is positive that these investors have done the work to
get themselves set up, that they want to look at and get
involved in this market," said Greg Moore, head of US fixed
income at TD Bank, who acted as lead manager on both the Fannie
Mae and World Bank transactions. "It’s going to be
a long, long process before the world is done with Libor, but
the more institutions that are looking at Sofr, and thinking
more in Sofr terms, be it issuers or investors, that is a
positive for the development and adoption of Sofr."
to access IFLR's series of primers
DEAL: Fannie Mae's Sofr-linked
ARCC chair to market: Sofr is first real