The Secured Overnight Financing Rate (SOFR) is the overnight interest rate used for US dollar-denominated loans and derivatives in the overnight market. It indicates how much a bank will have to pay to borrow cash from another institution.
The rate is underpinned by US treasury securities, which a bank will offer as collateral to secure their overnight cash loans. These loans are a vital part of trading derivatives, as they allow parties to speculate on interest rates and borrowing costs.
What is the SOFR rate history?
Up until the 2008 financial crisis, global central banks all used the LIBOR rate as a peg for credit agreements. When dozens of banks were found to be manipulating the data LIBOR was based on, a lot of banks became wary of relying on the benchmark.
The Federal Reserve assembled an Alternative Reference Rate Committee in 2017, the result of which was the selection of SOFR as the new overnight rate for dollar-denominated contracts.
The Fed began publishing the SOFR benchmark index in April 2018. While the two rates initially co-existed, in November 2020, it was announced that LIBOR would be completely phased out by June 2023.