The Secured Overnight Financing Rate or SOFR for short, is a benchmark interest rate created by the US Federal Reserve. The SOFR has recently been implemented in order to better reflect the actual cost of borrowing cash overnight for large banking and financial firms. The financing interest rate is calculated using data from overnight repurchase agreement (REPO) transactions. REPO market transactions are essentially loans between market participants that are backed and collateralized by Treasury securities.
Banks, pension funds, insurance companies, brokers, money market funds and asset managing companies are some examples of participants active in the REPO markets.
Secured Overnight Financing Rate (SOFR) replaces LIBOR
The SOFR serves as a replacement for the London Interbank Offered Rate (LIBOR) in U.S. dollar-denominated derivatives and other financial contracts. LIBOR is not secured by Treasuries and is based on a survey of banks, which can be subject to manipulation. In fact, the LIBOR market had a major scandal where major banking institutions colluded to manipulate the LIBOR rate for their own benefit. Scandals aside, the usefulness of LIBOR started to wane after 2008 with less transactions taking place in the LIBOR markets. This prompted a need for a replacement benchmark lending rate that was more accurate and robust.
The SOFR has many advantages over LIBOR including that it is based on actual transactions as over $1 trillion dollars a day are traded in the REPO markets. This makes the SOFR a more accurate measure of the cost of borrowing cash for the participants of these markets. It is also seen as a risk-free alternative as transactions are backed by US Treasury bonds and notes.
The SOFR will also be used as the reference rate for a new type of overnight repo transaction called a standing repo facility. The standing repo facility will be available to a broad range of counterparties, including banks, broker-dealers, money market funds, and non-bank financial companies. The standing repo facility will help reduce funding pressures in the event of a market disruptions.
Where to get Secured Overnight Financing Rate (SOFR) Data?
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You can freely download or reference daily SOFR data and up to date interest rates from the Federal Reserve Bank of New York or from FRED at the Federal Reserve Bank of St. Louis.
About the Author:
Taylor Wilman is an experienced financial trader and stock market investor that writes for the InvestMacro finance blog.
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