Skip to content
All library documents

SOFR Discounting and Its Distinction from LIBOR Replacement

Article Quant Q&A · Author: Peaceful
Read the original

Summary

The answers clarify two separate benchmark changes: using SOFR as a reference for discounting cleared derivatives and replacing LIBOR as a floating-rate index. The discussion reports that clearing houses had moved discounting and price alignment interest to SOFR for relevant swaps, while federal funds OIS discounting remained a distinct convention that SOFR increasingly displaced. For dual-curve valuation, the discount curve and the projection curve serve different purposes; a LIBOR projection curve could coexist with SOFR discounting during the transition described.

SOFR is an overnight secured rate and does not capture the unsecured bank credit component embedded in USD LIBOR. The response therefore cautions that SOFR was not intended to reproduce every economic role of LIBOR, and mentions credit-sensitive alternatives as possible reference indices. It cites market adoption dates and historical fallback deadlines that apply to the period discussed; these should not be treated as current transition guidance without checking updated rules.

Key ideas

  • SOFR discounting and LIBOR replacement refer to related but distinct market changes.
  • Discounting uses a rate curve to value future cash flows, while projection estimates floating-rate payments.
  • SOFR and federal funds OIS are distinct benchmarks, though SOFR became a common discounting choice.
  • SOFR does not include the same unsecured bank credit component as LIBOR.
  • The stated transition dates are historical context and may not describe current rules.

Tags

Fixed incomeDerivatives pricingUS markets
Full text
# Is SOFR to replace LIBOR or Fed Fund Rate or both


# Is SOFR to replace LIBOR or Fed Fund Rate or both












I am a bit confused on what is going on regarding the new benchmark rate SOFR. My understanding is that SOFR is to replace Libor. However, I also get information on Fed fund OIS discounting is replaced by SOFR discounting .

## Answer by AKdemy (score 10, accepted)

https://quant.stackexchange.com/a/63897

The market is using SOFR discounting for all sorts of quotations already (not FF). For example, swaption vol is quoted with SOFR discounting, CME and LCH moved to SOFR PAI and discounting on Oct. 16 2020 on new AND legacy swaps.

For EUR cleared, major CCPs did this since July 27 2020.

The market switched to discounting with the relevant RFR rates on the dates above. Hence, if you have a dual stripped curve (e.g. 3m US libor), you use SOFR and no longer OIS (FF).

ISDA fallbacks will apply from 31 December 2021 for GBP, JPY, CHF and Euro-LIBOR and from 30 June 2023 for USD LIBOR. Note that the FED have issued supervisory guidance encouraging banks to “cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021”.

That said, it does NOT get rid of FF. It will co-exist, with SOFR being the more widely used (and being the choice for discounting).

## Answer by ir7 (score 5)

https://quant.stackexchange.com/a/63927

SOFR was never meant to take USD LIBOR's role, as USD LIBOR reflects unsecured funding (and is credit sensitive).

An index like BSBY, on the other hand, can. BoA just started issuing FRNs linked to it. A BSBY-SOFR basis swap was also struck a month ago.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.