SOFR, or the Secured Overnight Financing Rate, is a benchmark for the cost of borrowing cash overnight against U.S. Treasury securities in the repurchase-agreement, or repo, market. The Federal Reserve Bank of New York calculates the rate from transaction data and publishes it on business days at about 8:00 a.m. Eastern Time. It is now the preferred replacement for U.S. dollar LIBOR selected by the Alternative Reference Rates Committee, or ARRC.
The distinction matters because SOFR is a realized overnight, collateralized borrowing rate—not a bank’s estimate of its own unsecured funding cost, and not automatically a rate known at the start of a three-month borrowing period. Loans, futures and swaps use the benchmark in different ways to address those timing and pricing needs.
SOFR measures overnight Treasury repo borrowing
In a repo transaction, one party obtains cash while providing securities as collateral, with an agreement to reverse the transaction later. SOFR focuses on overnight borrowing secured by U.S. Treasury securities. The borrowing cost observed in that market is the raw material for the benchmark.
The New York Fed’s SOFR methodology draws on three parts of the Treasury repo market: tri-party repo, general collateral finance (GCF) repo and bilateral Treasury repo transactions. It calculates a volume-weighted median rather than a simple average. In broad terms, that means transaction volumes affect which observed rate sits at the middle of the day’s activity.
“Secured” is a defining part of the name. Treasury collateral supports the overnight borrowing, while “overnight” describes the maturity of the underlying transactions. A published SOFR fixing therefore reports one day’s broad market cost of this specific form of financing; it does not by itself state the interest charge for every type of dollar loan.
Transaction data replaced LIBOR’s bank-submitted estimates
SOFR’s design differs sharply from the former LIBOR approach. SOFR is transaction-based: the underlying repo activity regularly exceeds $1 trillion in daily volume, according to the ARRC and New York Fed. That depth makes the benchmark broad and difficult to manipulate.
LIBOR, by contrast, was built around bank-submitted estimates of unsecured borrowing costs. That difference is more than a change in calculation technique. It changes the economic exposure represented by the rate and helps explain why a contract tied to SOFR need not perform exactly as one tied to LIBOR, even if both are described as dollar interest-rate benchmarks.
ARRC selected SOFR as its preferred alternative to U.S. dollar LIBOR. The choice put a transparent, observed funding market at the center of the replacement framework, but it did not make all cash products and derivatives identical. Contract terms still determine such matters as the interest period, payment dates, spread and whether the rate is known in advance or only after overnight observations accumulate.
Treasury collateral changes what SOFR captures
A common shorthand describes SOFR as “the new LIBOR.” It can be useful as historical context, but it misses a material difference: SOFR is secured by Treasury collateral and generally does not incorporate bank credit risk. LIBOR-based rates did include that type of bank credit component.
As the U.S. Securities and Exchange Commission noted in its LIBOR-transition staff statement, SOFR and LIBOR-based rates can behave differently, particularly in periods of financial stress. A rise in concern about banks’ creditworthiness, for example, is not the same market development as a change in the cost of overnight borrowing secured by Treasuries.
This gap is often called basis risk: two reference rates may move differently because they measure different things. It was a central consideration for legacy contracts that converted from LIBOR. Replacing a reference-rate name without accounting for the underlying credit-risk difference can alter the economics of a loan, security or hedge.
That does not make one benchmark universally better for every use. Rather, it means parties should identify the exposure a contract is meant to reflect. SOFR captures secured overnight Treasury financing conditions; it is not designed as a direct measure of any individual bank’s unsecured credit risk.
An overnight fixing becomes a loan rate through compounding
Because SOFR is an overnight rate, a multi-day or multi-month obligation commonly cannot rely on a single fixing. Instead, contracts often use compounded SOFR over the applicable interest period. The result reflects the sequence of overnight rates actually observed during that period.
The New York Fed publishes 30-, 90- and 180-day compounded SOFR averages. It also publishes a SOFR Index, which supports compounding calculations over customized date ranges. The averages can be useful for standard periods; the index helps users calculate an equivalent compounded result when a contract’s dates do not line up with those standard windows.
A simplified 90-day loan sequence illustrates the difference. Each business day, an overnight SOFR observation becomes available. The contract’s calculation compounds the daily rates across its 90-day interest period, then applies the resulting rate—along with any contractual spread—to determine the interest due. The precise calculation conventions are contract-specific, but the essential point is that the realized rate is built over time.
That backward-looking feature can be desirable because it rests on observed transactions. It can also create an operational issue for a borrower seeking to know its exact interest cost before the period ends. Cash-market conventions can address payment timing, but the benchmark itself remains an overnight realized rate.
Term SOFR and compounded SOFR solve different cash-market timing needs
Compounded SOFR looks back at overnight rates that occurred. CME Term SOFR, on the other hand, is forward-looking: it is derived from market expectations implied by SOFR futures. The two rates are related to the same short-term-rate ecosystem, but they are not interchangeable labels for the same benchmark.
Term SOFR can give a borrower and lender a rate for an upcoming period at its start, which may suit selected cash-market products. CME Group Benchmark Administration says its Term SOFR benchmarks are intended for selected applications, including certain business loans, and support trillions of dollars in loans and revolving credit facilities.
For a revolving credit facility, knowing a forward-looking reference rate at the beginning of an interest period may make budgeting and administration more straightforward. For another product, a compounded overnight rate may be preferred because it tracks financing conditions realized during the period. The appropriate reference rate follows the product’s design, documentation and risk-management purpose—not merely the fact that both carry the SOFR name.
Term SOFR should not be confused with the overnight SOFR fixing administered by the New York Fed. One is a futures-implied forward-looking benchmark for selected uses; the other is the published measure of actual overnight Treasury repo borrowing.
SOFR futures and swaps turn realized overnight rates into hedgeable exposures
Borrowers, lenders, investors and dealers use SOFR futures and swaps to hedge or take positions on short-term U.S. interest rates. These instruments let market participants manage exposures linked to movements in rates even though the underlying benchmark is observed one overnight period at a time.
Three-Month SOFR futures provide a clear example. According to CME Group’s explanation of the contracts, final settlement is based on SOFR compounded over the contract’s reference quarter. The eventual settlement therefore reflects realized overnight SOFR readings over that quarter, rather than a forward survey of bank borrowing estimates.
Before settlement, the futures price incorporates market expectations about where overnight rates will be during the reference period. That creates a practical bridge between an observable overnight benchmark and a tradable, forward-looking interest-rate exposure. Swaps can similarly be structured to exchange cash flows tied to SOFR against other agreed payment streams, allowing parties to reshape rate exposure under their contract terms.
The hedge is not automatically perfect. A business with a Term SOFR loan, a compounded SOFR liability or a legacy exposure may face differences in timing, tenor, spread and benchmark behavior relative to its derivative. Matching the reference rate alone does not eliminate all basis or cash-flow risk.
Frequently Asked Questions
What does SOFR stand for?
SOFR stands for Secured Overnight Financing Rate. It measures the cost of overnight cash borrowing secured by U.S. Treasury securities in the repo market.
Who publishes the SOFR rate?
The Federal Reserve Bank of New York calculates and publishes SOFR each business day, using transaction data from specified Treasury repo market segments.
Is SOFR the same as LIBOR?
No. SOFR is based on secured Treasury repo transactions and generally excludes bank credit risk, while LIBOR was based on estimates of unsecured bank funding costs.
Why is compounded SOFR used?
One SOFR fixing applies only to overnight borrowing. Compounding combines daily observations across an interest period, producing a rate that can be used for longer-dated loan or derivative cash flows.
What is the difference between SOFR and Term SOFR?
SOFR is the realized overnight benchmark. Term SOFR is a forward-looking rate derived from SOFR futures expectations and is intended for selected cash-market applications.
How do Three-Month SOFR futures settle?
They settle against SOFR compounded over the contract’s reference quarter. The final outcome is thus tied to realized overnight rates over that period.
