SOFR vs. LIBOR:

Key Differences and Resulting Challenges for a LIBOR 

Transition

FCA Board Meeting

October 8, 2020

Clayton Milburn, Senior Financial Analyst

Office of Regulatory Policy

Finance and Capital Markets Team 1
Discussion:

 Contrasting SOFR and LIBOR

 Using SOFR for Loan Products – Challenges and Potential 

Solutions

 Market Status – SOFR Based Lending

 Development of Loan Products in the Farm Credit System

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Baseline: What is a Benchmark 

Interest Rate?

 Reflect the cost of borrowing money in different 

markets.

 Regularly updated interest rates that are publicly 

accessible.

 Calculated by an independent body.

“The data used to construct a Benchmark should be... anchored 

by observable transactions entered into at arm’s length...” 

(IOSCO Principles for Financial Benchmarks, 2013)

3
SOFR vs. LIBOR

SOFR LIBOR

Market Represented Treasury Repo Bank Unsecured 

Wholesale Financing

Maturity Points Overnight Only Overnight, 1-week, 1-

month, 2-months, 3-

months, 6-months and 

12-months

Underlying Transactions Overnight Repo Unsecured Deposits, 

Primary Issuance CP and 

CD’s.

Collateral U.S. Treasury 

Securities

Unsecured

Relative Market Depth $1 Trillion Daily < $500 Million Daily

Term Structure No Yes

Credit Sensitive Component No Yes

4
SOFR Loan Product Challenges

 Using an overnight rate in a market accustomed to 

term rates.

 Using a risk free rate in a market accustomed to a 

credit sensitive benchmark. 

 Keeping Loan Pricing, Funding, and Hedging in Sync.

 Having the systems and capabilities to support new 

products with new conventions.

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Overnight Rate Considerations

SOFR based products use an average of the daily indications 

over the reset period (1-month, 3-months, 6-months, etc.). 

LIBOR based products “fix” the rate paid at the start of the 

interest period based on forward looking term rates 

corresponding to the reset period.

With LIBOR – the interest due is known at the start of the 

payment period.

With SOFR – whether or not the interest due for the 

payment period is known at the outset depends... 

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Overnight Rate Considerations

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LIBOR SOFR – In Advance SOFR – In Arrears

Rate Known at 

Start of Billing 

Period?

Yes Yes No

Bill Rate Lags 

Market Rate?

Possibly Yes No

Can Be Used for 

Consumer or FCS 

Floating Rate 

Loans?*

Yes Yes Depends*

Hedged with 

Cleared Derivative 

Products?

Yes No Yes

*The use of “in arrears” conventions may be appropriate for some segments like syndicated credits to

capital markets participants, but present challenges for other borrower segments.
Overnight Rate Challenges

Gaining borrower acceptance of averaged rates.

Having systems in place to perform the necessary 

computations.

Aligning product conventions with disclosure requirements 

and standards.

The “push / pull” between funding providers (market 

investors) and borrowers.

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Market Developments and 

Potential Solutions

FRBNY Published SOFR Averages (30, 90, and 180 days) and a 

mathematical index to derive an average for any period.

ARRC recommended conventions (e.g., look-backs, lock-outs, 

etc.) for specified market segments.

Intent to develop a Term SOFR rate.

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Risk Free vs. Credit Sensitive 

Rates

In theory, LIBOR allowed “cost plus” pricing, without 

requiring borrowers to take on exposure to the price impacts 

of their lender’s own specific credit risk.

As credit spreads on bank funding increase due to economic 

stress, assets tied to LIBOR repriced in tandem with funding.

SOFR reflects rates on borrowings secured by U.S. Treasury 

Securities – a safe haven asset during times of economic 

stress. 

As credit spreads on bank funding increase in times of stress, 

the SOFR benchmark rate will tend to decrease, dropping 

yields on assets tied to SOFR.

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Risk Free Rate Challenges

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Risk Free Rate Challenges

Challenges in pricing SOFR based products.

SOFR countercyclicality and potential impacts on 

commitment utilization.

Balance sheet management constraints.

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Market Developments & Potential 

Solutions

FRBNY Private Sector Working Group to evaluate 

development of a credit sensitive add-on for SOFR.

Exploration of alternative indexes for certain rate products.

Not likely to be resolved prior to the end of 2021.

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Market Status – SOFR Based 

Lending

Slow to no movement to date, within the System and 

Broadly. 

Many lenders anticipate bringing SOFR products to market 

and begin SOFR based lending in the first quarter of 2021.

Fannie Mae and Freddie Mac pushing SOFR based ARMS.

The market may potentially move to a wider range of rates 

(beyond SOFR) for loan products.

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System SOFR Product 

Development

SOFR Based Administered Variable Rates.

FCS 1-Month Forward SOFR Index.

SOFR In Arrears.

SOFR in Advance.*

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Closing Thoughts

The switch from LIBOR to SOFR is not “plug-and-play.” The 

differences in the rates themselves present multiple 

challenges to be overcome. 

System institutions continue to develop products to facilitate 

the transition. 

The SOFR products we see today will likely continue to 

evolve in response to market developments.

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