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SOFR is a risk-free reference rate (“RFR”) selected as the rate for usage in certain United States Dollar (“USD”) derivatives and other financial contracts, by the Alternative Reference Rates Committee (“ARRC”) of the Federal Reserve Bank of New York (“NY Fed”) in the year 2017.
It is the preferred alternative to USD LIBOR.
SOFR is the benchmark interest rate for dollar-denominated derivatives and loans produced by the NY Fed in cooperation with the Office of Financial Research and published on each business day at 8:00 a.m. Eastern Time, tentatively. It is the measure of the cost of borrowing cash overnight collateralized by the United States Treasury securities in the repurchase option / agreement market. Since the rate is based on actual transactions unlike LIBOR settings, SOFR provides an accurate means of measuring the cost of borrowing money.
Fixed-income instruments including floating rate notes, loans, and mortgages are generally linked to a term rate based on tenors of 1, 3, 6 or 12 months just like LIBOR. Since SOFR is also an overnight rate, it is required to be compounded daily to get an equivalent term rate.
Term SOFR represents an indication of the forward-looking measurement of overnight SOFR, which is based on market expectations implied from derivative markets.
The ARRC has officially recommended the usage of the forward-looking SOFR term rates which are published by the Chicago Mercantile Exchange Group (“CME”) (the NY Fed’s appointed administrator).
This article does not discuss the development and use of forward-looking term rates in respect of RFRs other than SOFR. Stakeholders transitioning away from LIBOR settings in currencies other than USD, must consider the recommendations of the relevant RFR supervisory authority and working group. For instance, in the United Kingdom, the usage of term Sterling Overnight Index Average (“SONIA”) is expected to be limited. In fact, the Bank of England as well as the Financial Conduct Authority have strongly endorsed the usage of SONIA compounded in arrears for transition away from GBP LIBOR settings.
Ankit Sinha
Partner, Juris Corp
Email: ankit.sinha@jclex.com
Akshay Kelkar
Associate, Juris Corp
Email: akshay.kelkar@jclex.com
Dhwani Bansdawala
Associate, Juris Corp
Email: dhwani.bansdawala@jclex.com