Years before the British expect to phase out Libor, the London Interbank Offered Rate that serves as a benchmark to price trillions of dollars’ worth of loans and derivatives globally, the Federal Reserve Bank of New York has introduced a substitute.
It’s called the Secured Overnight Financing Rate, or SOFR, and it’s intended for use as an “alternative to U.S. dollar Libor for use in certain new U.S. dollar derivatives and other financial contracts,” according to the New York Fed.
The expectation is that SOFR will eventually replace Libor, which has been used as a benchmark for borrowing rates on variable-rate mortgages, student loans and credit cards, subject to an additional spread. A loan, for example, would charge borrowers Libor plus 1% or Libor plus 50 basis points.
Though Libor was widely accepted by lenders and borrowers alike for years, it was actually set by a group of bankers in London reporting the average of estimated interest rate banks would be charged to borrow from each other on loans of different maturities and currencies.
In 2012, investigations by regulators in Europe and the U.S., prompted by a series of articles in The Wall Street Journal in 2008, found that several bankers were manipulating Libor rates, costing billions in overpayments by borrowers and ultimately billions in fines for several banks.
The new SOFR, unlike Libor, is based on actual transactions in a deep and liquid market — the U.S. Treasury market, according to the New York Fed. Originally developed by the Alternative Reference Rate Committee (ARRC), it’s designed to initially work alongside Libor, but regulators reportedly hope it will eventually become the benchmark for loans and derivatives.