How did SOFR replace LIBOR?

The Secured Overnight Financing Rate (SOFR) replaced the London Interbank Offered Rate (LIBOR) as the primary US dollar interest rate benchmark following a multi-year transition that concluded in mid-2023. The shift was driven by the LIBOR manipulation scandal of 2012, which revealed that major banks had been submitting false rate estimates to benefit their trading positions.

LIBOR was fundamentally flawed because it was based on banks' self-reported estimates of borrowing costs rather than actual transactions. As interbank lending declined after 2008, the rate became increasingly detached from real market activity. The Alternative Reference Rates Committee (ARRC), convened by the Federal Reserve, selected SOFR in 2017 as the replacement benchmark because it is grounded in approximately $1 trillion in daily overnight repurchase agreement transactions secured by US Treasury collateral.

The transition required enormous operational effort across the financial system. Trillions of dollars in floating-rate loans, derivatives, mortgages, and bonds referenced LIBOR, and each contract needed to be amended or replaced. New SOFR-based term rates were developed, fallback language was standardized, and market conventions were rewritten. The CME Group developed the forward-looking CME Term SOFR to provide a LIBOR-like forward-looking reference that market participants needed for loan pricing.

Key differences between SOFR and LIBOR matter for practitioners. SOFR is a secured rate (backed by Treasury collateral) while LIBOR was unsecured, so SOFR runs lower and does not embed bank credit risk. SOFR is an overnight rate while LIBOR had term tenors (1-month, 3-month, 6-month), requiring conventions for compounding or averaging to create term equivalents. Because SOFR lacks a credit risk component, some loan markets adopted credit-sensitive alternatives like Bloomberg BSBY or Ameribor alongside SOFR, though SOFR dominates derivatives and most new floating-rate debt.