One of the biggest events in derivatives history just happened quietly in the background of most commercial real estate transactions. Here is what actually changed, what it meant for caps already in place, and what every borrower needs to understand about the rate their cap references today.
What This Guide Covers
The LIBOR-to-SOFR transition touched every floating-rate loan and every interest rate cap written before mid-2023. This guide explains the full story — from why LIBOR collapsed to what your cap documents should say today.
What LIBOR Was and Why It Failed
For nearly four decades, the London Interbank Offered Rate was the most important number in global finance. It sat underneath hundreds of trillions of dollars of financial contracts — mortgages, student loans, business credit, corporate bonds, and hundreds of thousands of commercial real estate loans across the United States. Every interest rate cap written for a US floating-rate property loan before 2022 almost certainly referenced LIBOR as its index.
LIBOR was a family of benchmark rates published daily by the ICE Benchmark Administration. Banks across multiple currencies and tenors submitted rates representing what they believed they could borrow unsecured in the interbank market. The administrator collected these submissions, trimmed the top and bottom quartiles, and published the average as the official LIBOR rate. For US dollar borrowers, the most common tenors were 1-month, 3-month, and 6-month USD LIBOR.
The problem was structural: LIBOR was based on what banks believed they could borrow — not on what they were actually paying. In practice, the interbank unsecured lending market had shrunk dramatically after the 2008 financial crisis. By the mid-2010s, very few actual transactions underpinned LIBOR rates. Banks were largely making informed estimates, not reporting real deals. That created an opening for manipulation.
The scandal that ended LIBOR
In 2012, regulators in the US, UK, and Europe confirmed what investigators had suspected: traders at multiple major banks had been manipulating LIBOR submissions to benefit their own derivatives positions. The scandal involved banks submitting artificially low rates during the 2008 financial crisis to appear financially healthy, and submitting rates at specific levels to benefit trading desks that held large positions in LIBOR-linked derivatives.
The settlements were enormous. Barclays, Deutsche Bank, UBS, and several other institutions paid billions in fines collectively. More importantly, the scandal destroyed confidence in the benchmark itself. If a rate is meant to represent market conditions but is actually being set by submitting banks who have financial incentives to distort it, the entire architecture of contracts referencing that rate is built on sand.
In 2017, Andrew Bailey of the UK’s Financial Conduct Authority made the announcement that set a five-year countdown in motion: the FCA would no longer compel banks to submit LIBOR rates after the end of 2021. The market had until then to transition to something better.
⚠️ Timeline note: Most LIBOR settings ceased at the end of 2021. USD LIBOR was given an extended transition period and continued publishing for legacy contracts through June 30, 2023 — when the final USD LIBOR settings were permanently discontinued. After that date, any contract that still referenced USD LIBOR without a valid fallback was in a legal grey zone.
How SOFR Was Chosen as the Replacement
The Alternative Reference Rates Committee — known as the ARRC — was convened by the Federal Reserve and the New York Fed in 2014 to identify a replacement for USD LIBOR. The ARRC included major banks, asset managers, broker-dealers, the US Treasury, the CFTC, the OCC, and the FDIC. Its job was to find a rate that fixed LIBOR’s central failure: the lack of actual transaction data underneath it.
In 2017, the ARRC selected the Secured Overnight Financing Rate as its preferred alternative. SOFR is based on actual overnight repurchase agreement transactions in the US Treasury market — a market with trillions of dollars of daily volume. Unlike LIBOR, SOFR has real data behind it every day. It cannot be manipulated through bank submissions because it is calculated from observable market transactions published by the Federal Reserve Bank of New York.
Why SOFR and not other candidates
The ARRC evaluated several potential alternatives before selecting SOFR. Other candidates included the Effective Federal Funds Rate, an overnight bank funding rate, and various term rate alternatives. SOFR won on the key criteria that mattered most: transaction volume, robustness to stress, and regulatory preference. The repo market underlying SOFR trades over $1 trillion per day — orders of magnitude more than the activity underlying LIBOR at the time of discontinuation.
SOFR also had one important characteristic that was different from LIBOR by design: it is a risk-free rate. LIBOR embedded a bank credit premium because banks borrowing unsecured from each other charge credit risk. SOFR is secured by Treasury collateral — the safest collateral in the US market — so it carries no credit component. That structural difference is important for cap holders, and we will examine it in detail in the comparison section below.
LIBOR vs. SOFR: Key Structural Differences for Cap Holders
Understanding the transition requires understanding what actually changed. LIBOR and SOFR are not simply two names for the same thing — they are structurally different rates with different properties that affect how caps price, perform, and behave. The comparison below is specific to the cap holder’s perspective.
The credit component difference — why it matters for caps
The most important structural difference for anyone who owned a LIBOR-based cap is the credit component. LIBOR historically traded 15–50 basis points above overnight risk-free rates in normal times — and this spread could widen dramatically during banking stress. In September–October 2008, the 3-month LIBOR–OIS spread widened to over 350 basis points, meaning LIBOR was pricing in extreme bank credit risk on top of the policy rate.
For a borrower holding a LIBOR cap during that period, this meant the cap was very deeply in-the-money for reasons that had nothing to do with the Federal Reserve’s policy decisions — the spread between LIBOR and the policy rate was itself driving settlement payments. SOFR does not contain this credit component. A SOFR cap responds primarily to monetary policy decisions rather than to bank credit market conditions.
Whether this is an advantage or disadvantage for cap holders depends on circumstances. During a pure banking crisis where the Fed is cutting rates but LIBOR is widening on credit fear, a LIBOR cap would have provided more protection than a SOFR cap. In a normal monetary tightening cycle — the environment most CRE cap buyers are pricing for — the two behave similarly.
All current cap quotes reference Term SOFR. The Waldev interest rate cap calculator uses the current SOFR environment to estimate your premium. Run your deal parameters now to see where SOFR-based cap costs currently land.
Estimate My SOFR Cap →Fallback Language and the ISDA Protocol
The most technically complex part of the LIBOR transition for cap holders was the question of what happened to existing contracts. A cap confirmation is a legal document that says “this agreement pays when LIBOR exceeds [strike].” When LIBOR is discontinued, that reference has nowhere to go unless the contract contains explicit instructions for what to do. Those instructions are called fallback language.
The fallback waterfall
Fallback language provides a hierarchy of steps — a waterfall — that defines what rate replaces LIBOR when the primary rate is unavailable. The ARRC’s recommended hardwired fallback language for loans, and ISDA’s fallback protocol for derivatives, both created similar waterfalls. Here is how the standard ISDA fallback waterfall worked for an interest rate cap:
The cap confirmation references USD LIBOR for the applicable tenor. This rate is used if it is available and not subject to a Benchmark Transition Event.
If LIBOR is permanently discontinued, the fallback rate is Term SOFR for the matching tenor, plus the fixed credit spread adjustment determined by ISDA (set at the five-year historical median of the LIBOR-SOFR basis). For 1-month USD LIBOR this adjustment was 11.448 bps; for 3-month it was 26.161 bps.
If Term SOFR is also unavailable, the fallback is SOFR compounded over the interest period in arrears, plus the spread adjustment. This fallback exists because Term SOFR is a derived rate (from futures) and could theoretically become unavailable.
If compounded SOFR in arrears is unavailable, a simple average of daily overnight SOFR rates over the interest period, plus the spread adjustment, is applied.
If all SOFR-based fallbacks are unavailable, the Calculation Agent polls reference dealers for their view of the applicable rate. This is the final backstop — rarely expected to be needed.
The ISDA Fallback Protocol — opt-in mechanism
For most over-the-counter derivatives including interest rate caps, ISDA published the 2020 ISDA IBOR Fallbacks Protocol. By adhering to this protocol, counterparties agreed that the standard fallback language would apply to all their covered derivatives governed by ISDA Master Agreements — past and future, without needing to amend every individual confirmation.
The adherence process was straightforward: a counterparty submitted an adherence letter to ISDA, which ISDA published on its public register. Once both counterparties in a trade had adhered, the protocol applied to their bilateral derivatives. The major dealer banks adhered early, which meant that for most CRE borrowers whose caps were purchased from bank dealers, the fallback was automatically in place without any action required on the borrower’s part.
What if my loan and cap had different fallback language?
One of the trickier scenarios during the transition was when a loan and its associated cap had different fallback languages — the loan might reference the ARRC’s hardwired language, while the cap confirmation referenced the ISDA protocol, or vice versa. In most cases, the economic outcome was very similar (both transitioning to SOFR plus a credit spread adjustment), but the exact timing of when the fallback was triggered, and which spread adjustment applied, could differ slightly.
For borrowers in this situation, it was worth having a legal advisor or derivatives consultant review whether the loan and cap were economically aligned after their respective fallbacks triggered. Most instances resolved without material difference.
What about caps with no fallback language?
Some very old cap confirmations — particularly those drafted before the industry became aware of the LIBOR transition in 2017–2018 — contained no fallback language at all, or contained deeply inadequate fallback language (such as referencing “the last available LIBOR setting” with no further instruction). For US contracts, the Adjustable Interest Rate (LIBOR) Act of 2022 provided a federal backstop: any USD LIBOR contract without a valid replacement mechanism would automatically convert to the applicable SOFR-based rate as determined under the Act. This federal solution prevented the worst-case scenario of truly stranded contracts.
💡 Practical outcome for most CRE cap holders: If your cap was purchased from a major bank dealer after 2019, it almost certainly contained adequate fallback language or your dealer adhered to the ISDA protocol. The transition happened automatically on June 30, 2023. Your cap now references Term SOFR plus the applicable credit spread adjustment, with the same strike rate and notional. No new cap was required.
What Actually Happened to In-Flight Caps
For borrowers who had purchased LIBOR-based interest rate caps before the transition — perhaps on a 3-year bridge loan that was still active in 2022 or 2023 — the practical experience of the transition was less dramatic than the legal complexity suggested. Here is the sequence of what actually happened.
Pre-transition: 2020–2022
During this period, most cap confirmations still referenced USD LIBOR as their primary floating rate index. Settlement calculations were still being done against LIBOR. New caps were increasingly being quoted with fallback language (some dealers even began quoting SOFR-based caps by 2021), but legacy LIBOR caps continued to function normally until LIBOR was actually discontinued.
For borrowers, the most visible change during this period was in new loan documentation. ARRC-endorsed fallback language began appearing in new CRE loan agreements from 2019 onward. Borrowers closing new bridge loans in 2021 or 2022 typically received loan documents with hardwired SOFR fallback provisions, even though the current rate was still LIBOR. This created the odd situation where new loan documents and their associated cap confirmations were increasingly cross-referencing SOFR as a future state, while current payments were still being calculated on LIBOR.
June 30, 2023: The trigger date
When the final USD LIBOR settings were published on June 30, 2023, every LIBOR-based cap that had adequate fallback language automatically converted. The mechanism was not a choice or a notification — it was a contractual event that occurred by operation of the agreements. The Calculation Agent (typically the dealer bank) was responsible for applying the fallback rate from the next scheduled fixing date after June 30, 2023.
For a borrower with a 1-month LIBOR cap, the first reset after June 30 would have been calculated using Term SOFR (1-month) plus 11.448 basis points rather than 1-month USD LIBOR. The strike rate in the confirmation did not change. The notional did not change. The term did not change. The only thing that changed was the floating rate index used to determine whether the cap was in-the-money on any given reset date.
What changed
- Floating rate index: from USD LIBOR to Term SOFR
- The credit spread adjustment was added to SOFR
- Calculation methodology for the floating rate
- Confirmation language (amended by protocol)
What didn’t change
- Strike rate (same numerical level)
- Notional amount
- Cap term and termination date
- Premium already paid (sunk cost)
- Lender assignment
- ISDA Master Agreement
Action required by most borrowers
- None for standard ISDA protocol adherent caps
- Confirm your dealer adhered to the ISDA protocol if uncertain
- Review updated confirmation if dealer sent amended document
- Check that loan and cap now reference same rate after both transitions
The SOFR Spread Adjustment Explained
One of the most commonly misunderstood elements of the LIBOR-to-SOFR transition for cap holders is the credit spread adjustment. Understanding it matters because it determines whether a converted cap provides economically equivalent protection to the original LIBOR cap — or whether the conversion created a subtle change in the cap’s effective in-the-money level.
Why the spread adjustment was necessary
SOFR is structurally lower than LIBOR because SOFR contains no credit risk premium. In normal market conditions, 1-month USD LIBOR typically traded 5–30 basis points above the risk-free overnight rate equivalent. This spread varied over time and across rate environments, but it was consistently positive over a long historical period — meaning LIBOR was almost always higher than SOFR would have been for the same tenor.
If a cap with a 4.50% LIBOR strike were simply switched to reference SOFR with the same 4.50% strike and no adjustment, the cap would effectively have a higher in-the-money threshold — because SOFR starts from a lower base than LIBOR did. A borrower whose rate was 4.50% SOFR would have been 4.60%+ LIBOR. Without an adjustment, the cap would be slightly less protective than the borrower originally purchased.
The spread adjustment compensates for this structural difference. By adding the fixed historical median spread to SOFR, the converted cap preserves the economic equivalence of the original transaction.
How the adjustment amounts were set
ISDA used a five-year lookback period to calculate the median spread between LIBOR and SOFR (or its overnight rate equivalent) for each tenor. The spreads were fixed on March 5, 2021, when the FCA officially announced the cessation dates for most LIBOR settings. Fixing the spread on a specific historical date and freezing it for all future conversions gave the market certainty — there would be no ambiguity about what the adjustment would be on the actual transition date.
| LIBOR Tenor | SOFR Replacement | Credit Spread Adjustment | Basis | Example: Old Strike → Effective SOFR Threshold |
|---|---|---|---|---|
| 1-Month USD LIBOR | 1-Month Term SOFR | +11.448 bps | 5-yr historical median, fixed 5 March 2021 | 4.50% LIBOR strike → 4.50% still; SOFR threshold = 4.50% − 0.11448% ≈ 4.39% SOFR |
| 3-Month USD LIBOR | 3-Month Term SOFR | +26.161 bps | 5-yr historical median, fixed 5 March 2021 | 4.50% LIBOR strike → 4.50% still; SOFR threshold = 4.50% − 0.262% ≈ 4.24% SOFR |
| 6-Month USD LIBOR | 6-Month Term SOFR | +42.826 bps | 5-yr historical median, fixed 5 March 2021 | 4.50% LIBOR strike → 4.50% still; SOFR threshold = 4.50% − 0.428% ≈ 4.07% SOFR |
| 12-Month USD LIBOR | 12-Month Term SOFR | +71.513 bps | 5-yr historical median, fixed 5 March 2021 | 4.50% LIBOR strike → 4.50% still; SOFR threshold = 4.50% − 0.715% ≈ 3.78% SOFR |
⚠️ Important framing: The strike rate in the cap confirmation itself did not change numerically. What changed was the index it measured against. If your cap said “pays when LIBOR exceeds 4.50%,” after conversion it effectively says “pays when Term SOFR plus 11.448 bps exceeds 4.50%” — which means it pays when SOFR exceeds approximately 4.39%. The economic exposure is preserved, not materially altered, but the actual SOFR level that triggers in-the-money is lower than the stated strike.
If you’re pricing a new interest rate cap, there is no LIBOR involved at any level — the whole system is SOFR. Use the rate cap calculator to estimate your premium using current Term SOFR forward rates and your required strike level.
Basis Risk During the Transition Period
Basis risk is the risk that two rates which are supposed to move together actually diverge — and that divergence creates an unexpected gap in your hedge. During the LIBOR-to-SOFR transition, a specific and important form of basis risk emerged for some CRE borrowers: situations where the loan and the cap converted at different times, or where one document used a LIBOR-based reference while the other had already moved to SOFR.
The mismatch scenario
Consider a borrower who closed a bridge loan in mid-2022. The loan documents used ARRC-recommended hardwired fallback language, which transitioned the loan to SOFR upon LIBOR cessation. However, the associated cap confirmation used older ISDA documentation that was less clear, and the dealer required an amendment and acknowledgment process before the cap formally converted.
For a brief window — say a few months in late 2022 or early 2023 — the loan was calculating interest on one basis while the cap was being settled on another. The loan might accrue interest at the current LIBOR rate for that reset period, while the cap’s settlement was calculated against SOFR. If LIBOR and SOFR moved similarly, the economic impact was trivial. If they diverged — as they could during banking stress, when LIBOR’s credit component widened but SOFR did not — the hedge would have underperformed by precisely that credit spread.
Why basis risk matters for cap holders specifically
A borrower’s interest rate cap is meant to provide protection that exactly mirrors the loan’s interest rate exposure. If the loan pays LIBOR and the cap pays when LIBOR exceeds the strike, the hedge is perfect. If the loan pays LIBOR but the cap pays when SOFR exceeds the strike, there is a systematic basis risk equal to the LIBOR-SOFR spread.
In a stress scenario where that spread widens — exactly when a borrower most needs their cap to work — the cap might settle at a slightly lower amount than the loan’s actual interest burden. The magnitude of this basis risk was generally modest (a few basis points in normal conditions, up to perhaps 50–100 basis points in acute stress), but for large loans or caps with long terms, even small basis differences compound into meaningful dollar amounts.
Illustrative basis risk scenario
Loan: $20 million, paying 1-Month LIBOR + 2.50%
Cap: $20 million, now converted to SOFR after early adherence
Scenario: Brief banking stress event. 1-Month LIBOR spikes 30 bps above Term SOFR due to credit widening.
Loan interest (per month): Based on LIBOR (higher by 30 bps) = +$5,000/month extra vs. cap settlement
Cap settlement: Calculated on SOFR (lower) — cap pays less than borrower’s actual rate increase by ~$5,000/month
Over 6 months of stress: ~$30,000 gap — real money, but manageable relative to total cap premium paid.
How borrowers resolved basis risk
The most straightforward resolution was ensuring both the loan and cap documents transitioned simultaneously and to the same rate. Borrowers who proactively amended cap confirmations before the cessation date — rather than waiting for automatic fallback — could control the timing of both transitions and minimise the window of mismatch.
After June 30, 2023, this risk largely resolved. With LIBOR permanently discontinued, both the loan and cap now reference SOFR. There is no longer a structural basis risk between the two — unless a borrower is somehow in an unusual legacy situation with non-standard documentation that references something other than SOFR.
✅ Current status: For any new cap purchased today, basis risk between the loan and the cap does not exist if both reference the same SOFR tenor (typically 1-Month Term SOFR). This is one area where the post-transition environment is actually cleaner and more transparent than the old LIBOR system.
How Cap Pricing Changed After the Switch
One of the questions borrowers and treasury teams most frequently asked during the transition was whether SOFR-based caps would price differently than LIBOR-based caps. The short answer is: the pricing mechanics are essentially the same, but there are some structural nuances worth understanding.
The Black-76 model still drives the premium
Interest rate cap pricing in both the LIBOR era and the SOFR era uses variants of the Black-76 model — a framework that takes the forward rate, the strike, the notional, the time to expiry, and the implied volatility of the relevant rate to calculate an option premium for each caplet in the cap structure. The transition to SOFR did not change this fundamental pricing mechanism.
What changed was the inputs: the forward curve now reflects expected SOFR levels rather than expected LIBOR levels, and the implied volatility surface reflects trading activity in SOFR swaptions rather than LIBOR swaptions. The good news is that both markets are active and liquid, so the inputs are market-observable and reliable.
Forward curve differences
In the LIBOR era, cap dealers derived forward rates from LIBOR swap rates — the rates at which the market expected LIBOR to reset over future periods. In the SOFR era, forward rates come from the SOFR OIS curve and SOFR futures. The SOFR forward curve is typically slightly lower than the equivalent LIBOR forward curve would have been, by approximately the expected LIBOR-SOFR spread for the relevant tenor. This is structurally consistent: because SOFR is a risk-free rate with no credit component, its expected future levels are modestly lower than LIBOR’s expected future levels were.
For cap buyers, this means SOFR-based forward rates tend to be slightly lower than LIBOR-based forward rates would have been for the same economic environment. All else equal, a cap with a given numerical strike costs slightly less when priced off the SOFR forward curve than it would have off the LIBOR forward curve — because the lower forward rates make the cap slightly less likely to be in the money. The credit spread adjustment in converted caps partially compensates for this.
| Pricing Input | LIBOR Era | SOFR Era | Impact on Premium |
|---|---|---|---|
| Forward Rate Source | LIBOR swap rates / LIBOR OIS curve | SOFR OIS curve, SOFR futures, CME Term SOFR | Slightly lower forward rates → slightly lower premium, all else equal |
| Discount Rate | Originally LIBOR; shifted to OIS discounting ~2013 | SOFR OIS discounting | Minimal change — OIS discounting was already standard pre-transition |
| Implied Volatility | LIBOR swaption implied vol | SOFR swaption implied vol | Generally comparable; SOFR vol market fully liquid by 2022 |
| Pricing Model | Black-76 / Normal (Bachelier) model | Black-76 / Normal (Bachelier) model | No change — same mathematical framework |
| Day Count Convention | Actual/360 for most USD LIBOR caps | Actual/360 for Term SOFR caps | No change |
| Settlement Timing | In arrears, based on LIBOR fixed 2 business days before period start | In advance for Term SOFR caps (rate known at period start) | Minor cash flow timing difference; economically similar |
The volatility surface transition
One legitimate concern during the early transition period was whether the SOFR swaption volatility market would be liquid and transparent enough to support reliable cap pricing. LIBOR swaptions had decades of trading history and deep market liquidity. SOFR swaptions were relatively new instruments.
By 2022–2023, this concern had been largely resolved. SOFR derivative trading volumes had grown substantially. CME Group’s SOFR futures provided deep liquidity for the Term SOFR derivation, and SOFR swaption markets were active enough to generate reliable implied volatility surfaces. Dealers pricing SOFR caps in 2023 onward were working from observed market data rather than from modelled approximations — which is exactly what a well-functioning cap market needs.
💡 Bottom line for pricing: If you are pricing an interest rate cap today, the SOFR-based premium you receive is determined by the same economic forces as a LIBOR-based premium would have been — forward rates, implied vol, time, and notional. The switch in reference rate did not make caps systematically cheaper or more expensive. It made them more transparent, more transaction-backed, and less vulnerable to a repeat of the manipulation problems that ended LIBOR.
How to Review Legacy Cap Documentation
If you hold an interest rate cap that was purchased before mid-2023 and you have not formally reviewed your documentation since the transition, it is worth taking 30 minutes to confirm that the conversion was completed correctly and that your cap now references the right rate. This is particularly important for caps that are still active — if you have outstanding cap protection that you are counting on in your cash flow model, you want to be certain the fallback applied cleanly.
The checklist below covers the key documentation points to verify. If you find anything that does not match what is expected, contact your cap dealer’s derivatives operations team directly — most large dealer banks have dedicated transition confirmation processes and will be able to confirm the status of your specific confirmation.
Your dealer may have sent an amended or restated confirmation after June 30, 2023. If you received such a document, review it to confirm that: (a) the floating rate index now references Term SOFR plus the applicable credit spread adjustment, (b) the strike rate is unchanged, (c) the notional and term are unchanged, and (d) the calculation agent is confirmed.
Check the ISDA public adherence register (available on ISDA’s website) to confirm that your dealer adhered to the 2020 ISDA IBOR Fallbacks Protocol. If your entity also adhered, the protocol applies bilaterally. If your entity did not adhere but your dealer did, you may need a bilateral amendment rather than protocol application — check with your dealer if there is any uncertainty.
For 1-Month Term SOFR: the spread adjustment should be +11.448 bps. For 3-Month Term SOFR: +26.161 bps. If you see a different number, or no spread adjustment at all, this warrants a call to your dealer’s operations team to clarify. The spread amounts were publicly published by ISDA and should be uniformly applied.
Review your loan agreement to confirm the floating rate index has transitioned from LIBOR to SOFR. If your loan was amended or if it contained hardwired fallback language, it should now reference the same SOFR tenor as your cap. If the loan and cap reference different SOFR tenors (e.g., loan uses 1-month Term SOFR but cap used 3-month Term SOFR), you have a basis risk that should be reviewed.
Your cap assignment agreement directs settlement payments to your lender. Confirm with your lender that they have received updated documentation reflecting the SOFR-based cap, and that the assignment remains in force. Some lenders sent formal confirmation letters to borrowers confirming the transition was acceptable under the loan agreement — if you received such a letter, file it with your closing documents.
On the next scheduled settlement date after your review, verify that the settlement amount was calculated correctly under the SOFR-based methodology. Compare the settlement notice (if your dealer provides one) against your own calculation using the published Term SOFR fixing for the relevant period plus the spread adjustment, versus your strike. If numbers don’t reconcile, contact the dealer’s calculation agent promptly.
If you maintain a cash flow model for your property, update it to reflect Term SOFR as the floating rate index rather than LIBOR. Forward rate assumptions, sensitivity tables, and DSCR stress tests should all reference Term SOFR forward rates going forward. Outdated models still referencing LIBOR forward curves will produce incorrect projections.
Once you’ve confirmed your cap references Term SOFR, run updated settlement projections using the Waldev interest rate cap calculator. Input current Term SOFR levels, your strike, and remaining cap term to see projected settlement scenarios going forward.
Term SOFR: The Practical Solution for CRE Caps
One of the early concerns about replacing LIBOR with SOFR in commercial real estate was practical: LIBOR was a forward-looking term rate. A borrower knew at the start of a monthly interest period exactly what rate they would pay for that period. SOFR in its overnight form is a backward-looking rate — you only know what it compounded to at the end of the period, not at the beginning.
For commercial real estate borrowers and lenders accustomed to knowing their interest payment in advance, backward-looking compounded SOFR created operational challenges. How do you know how much to wire before the period ends? How do you model a cap if you don’t know what the reference rate will be until after the period is over?
CME Term SOFR solves the forward-looking problem
CME Group publishes Term SOFR rates — 1-month, 3-month, 6-month, and 12-month — derived from SOFR futures markets. Like LIBOR, Term SOFR is known at the start of the interest period. A loan accruing interest at 1-Month Term SOFR plus a spread will have its rate fixed at the beginning of the month, exactly as a 1-Month LIBOR loan would have worked.
The ARRC endorsed Term SOFR for use in business loans, multifamily mortgages, and floating-rate CRE transactions where the operational need for a forward-looking rate is clear. Term SOFR is now the standard reference for virtually all new US CRE bridge loans, construction loans, and their associated interest rate caps.
Term SOFR vs. Compounded SOFR in Arrears
Term SOFR (forward-looking): Published at the start of each period. Rate is known in advance. Operationally identical to how LIBOR worked. Suitable for caps, loans, and any product where advance rate knowledge matters. Published by CME Group under a license.
Compounded SOFR in Arrears (backward-looking): Calculated by compounding daily overnight SOFR over the interest period. Only known at period end. More accurate representation of actual overnight rate experience. Used in some ISDA-standardised derivatives and by some capital markets participants, but operationally difficult for loans and CRE caps.
Most US CRE caps now use Term SOFR as their reference.
Who publishes Term SOFR and is it reliable?
CME Group’s Term SOFR reference rates are published daily at 6:00 AM Eastern time for tenors of 1-month, 3-month, 6-month, and 12-month. The rates are derived from the prices of SOFR futures contracts trading on CME — a highly liquid market with deep institutional participation.
The ARRC reviewed and endorsed CME’s Term SOFR methodology. The publication process is transparent, the inputs are observable market transactions, and the rate is licensed for use by financial institutions. It does not have the manipulation risk that LIBOR had, because it is derived from futures market prices rather than bank submissions.
One note: because Term SOFR is derived from futures and not directly from transactions in the underlying overnight market, it sits one level of abstraction above the most direct SOFR measurement. ARRC documentation includes caveats about appropriate use cases — but for CRE lending and associated caps, Term SOFR is the endorsed, standard choice.
| Feature | LIBOR | Overnight SOFR | Compounded SOFR | Term SOFR |
|---|---|---|---|---|
| Forward-looking? | Yes | No (daily) | No (end of period) | Yes |
| Rate known at period start? | Yes | No | No | Yes |
| Manipulation risk | High (bank submissions) | Low (transactions) | Low (transactions) | Low (futures market) |
| Credit component | Yes (bank credit) | None | None | None |
| Standard for CRE caps? | Was (pre-2023) | No | Some institutional | Yes (current standard) |
| Publisher | ICE (discontinued) | NY Fed | NY Fed / SOFR index | CME Group |
Frequently Asked Questions
What happened to my interest rate cap when LIBOR was discontinued?
If your cap was purchased from a major dealer bank and either you or your dealer adhered to the 2020 ISDA IBOR Fallbacks Protocol, your cap automatically converted from USD LIBOR to Term SOFR plus the applicable credit spread adjustment on June 30, 2023. The strike, notional, term, and premium you paid were not affected — only the floating rate index changed.
Most borrowers received no formal notification beyond possibly an updated confirmation or an email from their dealer’s operations team. The conversion was a contractual event that occurred automatically by operation of the fallback provisions — it did not require your consent or action.
If you are uncertain whether your cap converted correctly, contact your dealer’s derivatives documentation team and request confirmation of the current reference rate in your cap confirmation.
Did I need to buy a new cap when LIBOR ended?
No. Existing caps with adequate fallback language converted automatically — they were not cancelled, terminated, or replaced. The same legal agreement continued, with the index provision amended by operation of the fallback. You did not need to pay a new premium, execute a new ISDA confirmation, or go through a new dealer selection process.
The only borrowers who needed to take affirmative action were those with very old caps containing inadequate or missing fallback language, and even many of those were covered by the SOFR Act’s federal backstop provision for stranded USD LIBOR contracts.
Is Term SOFR the same thing as SOFR?
Term SOFR is a forward-looking rate derived from SOFR futures markets, published by CME Group. It is related to but not identical to overnight SOFR. Overnight SOFR is the underlying rate published by the NY Fed based on actual repo transactions. Term SOFR uses futures market prices to project what SOFR is expected to average over the relevant period (1 month, 3 months, etc.).
In practice, Term SOFR tracks overnight SOFR closely over time, but they are not mathematically identical. Term SOFR tends to be slightly higher than a simple average of overnight SOFR over the same period when the market expects rates to rise, and slightly lower when rates are expected to fall. For CRE caps and loans, Term SOFR is the standard reference because it is forward-looking and known at the start of each interest period — just like LIBOR was.
How does the LIBOR-SOFR transition affect my DSCR calculations?
If your debt service coverage ratio model was built around LIBOR-based interest calculations, you should update it to reference Term SOFR. Because SOFR does not include a bank credit premium, SOFR-based interest rates will in most normal conditions be slightly lower than equivalent LIBOR-based rates — meaning DSCR calculations at a given rate level will look slightly better under SOFR than they would have under LIBOR, all else equal.
For stress-testing purposes, the relevant question is not “what would LIBOR have done” but “what is Term SOFR expected to do.” Your DSCR stress tests should reference current Term SOFR forward rates for projected interest costs, and your cap’s in-the-money threshold should be compared against Term SOFR levels (not LIBOR levels) when modelling cap settlement scenarios.
If you’re using a cap calculator to model your protection level, ensure it references Term SOFR as the floating index. The Waldev calculator uses current SOFR-based inputs throughout.
What happens if Term SOFR is ever discontinued too?
This is a legitimate question, and the derivatives market has already prepared an answer. SOFR caps purchased today contain their own fallback provisions — if Term SOFR is ever discontinued, the fallback is typically compounded SOFR in arrears, then overnight SOFR with a lookback convention, then potentially a dealer poll. The fallback waterfall for Term SOFR caps is structurally similar to what existed for LIBOR caps, but with the key difference that SOFR itself is a transaction-based rate with no single point of failure from manipulation.
Term SOFR’s continued publication depends on the liquidity of SOFR futures — a market with deep institutional participation. Its discontinuation in the near to medium term would require either a failure of the SOFR futures market or a deliberate policy decision by regulators, neither of which is considered likely by market participants.
My loan was amended to reference SOFR before my cap converted. Was there a basis risk period?
Potentially, yes. If your loan document transition to SOFR occurred at a different time than your cap’s formal fallback transition, there was a window during which your loan accrued interest on one basis and your cap settled on another. The magnitude of the economic impact depended on how long the window lasted and how much LIBOR and SOFR diverged during that period.
In most cases, the economic impact was modest — particularly if the mismatch period was only a few months in 2022–2023 when LIBOR and SOFR moved closely together. However, if you experienced a significant settlement discrepancy during that period — where your cap paid considerably less than your increased loan interest — it is worth reviewing with your advisor whether the documentation was handled appropriately and whether any adjustment might be warranted.
Are there any LIBOR-related residual issues I should be aware of in 2025 and beyond?
For the vast majority of CRE borrowers, the LIBOR transition is fully resolved. LIBOR is gone, all properly documented caps have converted, and the market is operating smoothly on SOFR. The main residual situations to watch for are: (1) very old cap confirmations that may not have converted cleanly and were not reviewed post-transition; (2) cap assignments where lenders may not have formally acknowledged the rate index change in writing; and (3) financial models or spreadsheets that still reference LIBOR forward rates rather than SOFR forward rates for future projections.
If you have an active cap that you have never formally reviewed since June 2023, this guide’s documentation checklist is a useful starting point. Five years from now, any residual LIBOR issues will be very old and unusual — but in the near term, a brief documentation review is reasonable due diligence for any borrower with an active cap that was purchased before the transition.
Your Cap Now References Term SOFR — Make Sure Your Numbers Reflect It
Whether you’re reviewing an existing cap or pricing a new one, the reference rate is Term SOFR. Run your deal parameters through the Waldev calculator to see where SOFR-based cap premiums currently stand for your loan size, strike, and term.
Related Articles in This Series
This article is part of the Waldev interest rate cap knowledge series. If you found this guide useful, these related articles cover adjacent topics that cap holders should understand:
The free interest rate cap calculator uses current Term SOFR rates and market volatility to generate a benchmark premium estimate for your deal. It’s the fastest way to stress-test your cap cost before you contact dealers.
Disclaimer: This article is for educational and informational purposes only. The LIBOR-to-SOFR transition involved complex legal, regulatory, and documentation processes. All spread adjustment amounts, transition dates, and regulatory descriptions are provided as general educational context and may not reflect every individual transaction’s specific terms. The ISDA protocol adherence requirements, fallback waterfall mechanics, and SOFR Act provisions summarised here are generalisations — actual application to any specific cap agreement depends on the precise documentation in that agreement. Nothing in this article constitutes legal, financial, or derivatives advisory advice. Borrowers with questions about their specific cap documentation should consult a qualified derivatives advisor or legal counsel. The Waldev interest rate cap calculator provides indicative premium estimates for educational purposes and does not constitute a quote or offer to enter into a derivatives transaction.