The London Interbank Offered Rate (LIBOR) — for decades the world's most important benchmark interest rate, underpinning hundreds of trillions of dollars of financial contracts — was phased out beginning in June 2023, replaced in the U.S. market primarily by the Secured Overnight Financing Rate (SOFR). The transition was the culmination of years of regulatory effort following the 2012 LIBOR manipulation scandal, which revealed that the benchmark was based on panel bank submissions that were susceptible to manipulation.
LIBOR was a term rate — available in overnight, 1-month, 3-month, 6-month, and 1-year tenors — that embedded a bank credit risk premium, since it represented the theoretical rate at which banks would lend to each other in the interbank market. SOFR, by contrast, is a risk-free overnight rate based on actual overnight Treasury repurchase agreement (repo) transactions — a market with trillions of dollars of daily volume, making SOFR far more robust and transaction-based than LIBOR.
The structural difference between LIBOR and SOFR — particularly LIBOR's forward-looking term structure and bank credit risk premium vs. SOFR's overnight, risk-free nature — required adjustments in credit agreement documentation. A fixed credit spread adjustment (CSA) was established by industry bodies to account for the average historical difference between LIBOR and SOFR in each tenor: approximately 11 bps for 1-month, 26 bps for 3-month, and 43 bps for 6-month. These CSAs were added to SOFR to make the transition economically equivalent for legacy LIBOR contracts.
Term SOFR — a forward-looking version of SOFR published by the CME Group for 1-month, 3-month, and 6-month tenors — was developed to address market preference for term rates in loan markets (where knowing the interest payment in advance of the period is operationally convenient). Term SOFR is now the dominant reference rate in U.S. corporate and leveraged loan markets, having replaced LIBOR without significant market disruption.
For credit professionals, the LIBOR transition required updating thousands of loan agreements, derivative hedges, bond indentures, and systems. The "fallback language" embedded in credit agreements — the provisions that govern what happens when LIBOR is unavailable — became a major focus of documentation reform. The Adjustable Rate Mortgages (ARMs) Disclosure Act and related regulations also addressed the transition for consumer lending.