What is SOFR and why did it replace LIBOR?

For decades, much of the world's lending was linked to LIBOR. After a rate-rigging scandal, it was phased out. A new rate took its place for US dollar deals. This page explains what SOFR is, how it works and why Indian markets care about it.

Quick answer

SOFR, the Secured Overnight Financing Rate, is a benchmark interest rate for overnight borrowing in US dollars that is backed by US Treasury securities. It is published every business day by the Federal Reserve Bank of New York, based on actual repo market trades. SOFR replaced US dollar LIBOR, which stopped being published in its standard form after 30 June 2023.

Key takeaways

• It is a US dollar overnight rate backed by Treasury collateral.
• The New York Fed has published it since April 2018.
• It is based on real repo trades, not bank estimates.
• It replaced US dollar LIBOR after June 2023.
• India's Modified MIFOR uses SOFR as an input.

What is SOFR?

It measures the cost of borrowing cash overnight in US dollars when the loan is secured by US Treasury securities. This type of deal is called a repurchase agreement, or repo. Because the loan is backed by safe collateral, the rate carries very little credit risk.

The Federal Reserve Bank of New York publishes it each business day. It is based on a very large volume of actual repo transactions, which makes it hard to manipulate.

Why was LIBOR replaced?

LIBOR, the London Interbank Offered Rate, was based on estimates submitted by a panel of banks about what they would pay to borrow. After 2012, investigations found that some banks had tried to manipulate these submissions. Also, real interbank lending had become thin.

Regulators decided to move to rates based on real trades. In the US, a group called the Alternative Reference Rates Committee chose this rate in 2017. Publication began in April 2018. US dollar LIBOR in its standard panel form ended after 30 June 2023.

How is SOFR used?

Loans, bonds and swaps in US dollars now often pay a floating rate linked to SOFR. Since it is an overnight rate, contracts usually use SOFR compounded over the interest period, or forward-looking term SOFR rates derived from futures.

Because it has almost no credit risk, it can be lower than LIBOR was. Old contracts that moved away from LIBOR added a fixed spread adjustment to make up for this difference.

Why does SOFR matter for India?

Many Indian companies borrow in US dollars through external commercial borrowings. Their interest cost is now often linked to SOFR, so changes in US rates affect their finances.

In India, the old MIFOR benchmark combined USD LIBOR with rupee forward premiums. After LIBOR ended, FBIL moved to Modified MIFOR, which uses an adjusted SOFR rate instead. So the US rate now feeds into rupee-dollar interest rate swaps as well.

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