Secured Overnight Financing Rate (SOFR) is a secured overnight interest rate. SOFR is a reference rate (that is, a rate used by parties in commercial contracts that is outside their direct control) established as an alternative to LIBOR. LIBOR had been published in a number of currencies and underpins financial contracts all over the world. Deeming it prone to manipulation, UK regulators decided to discontinue LIBOR in 2021.[1]
In 2022, the LIBOR Act passed by the U.S. Congress established SOFR as a default replacement rate for LIBOR contracts that lack mechanisms to deal with LIBOR's cessation.[2] The Act also grants a safe harbor to LIBOR contracts that transition to SOFR.[2] Previously, SOFR was seen as the likely successor of LIBOR in the US since at least 2021.[1]
SOFR uses actual costs of transactions in the overnight repo market, calculated by the New York Federal Reserve.[1] With US government bonds serving as collateral for borrowing, SOFR is calculated differently from LIBOR and is considered a less risky rate.[1] The less risky nature of SOFR may result in lower borrowing costs for companies.[1] In addition, unlike the forward-looking LIBOR (which can be calculated for 3, 6 or 12 months into the future), SOFR is calculated based on past transactions, which limits the rate's predictive value on future interest rates.[1] In addition, SOFR is overnight, whereas LIBOR can have longer tenors.