What is SONIA?
SONIA was introduced by the Wholesale Market Brokers’ Association in 1998 and is the main benchmark for overnight unsecured money market transactions brokered in London and denominated in sterling. Since April 2016, SONIA has been administered by the Bank of England.
SONIA is calculated on a daily basis as the volume-weighted average of all unsecured loans executed between midnight and 6 pm (London time) with a value in excess of GBP 25m and a maturity of one business day. As a whole, the market that SONIA measures consists of deal volumes exceeding GBP 40bn every day. SONIA is best referred to as a ‘nearly RFR’ as an element of SONIA prices credit risk, albeit for the short tenor of overnight (where the window for default is comparatively short and any hint of an imminent creditworthiness issue is likely to result in a financial institution being excluded from the overnight market).
As of 23 April 2018, SONIA was reformed such that:
- The Bank of England has responsibility for the end-to-end administration of the benchmark, including calculation and publication
- The coverage of SONIA was broadened to include overnight unsecured transactions negotiated bilaterally as well as those arranged via brokers, using the Bank of England’s Sterling Money Market daily data collection as a data source
- The averaging methodology for calculating SONIA changed to a volume-weighted trimmed mean
- The publication of SONIA moved to 9am on the business day following that to which the rate pertains.
“[…] implementation of the reforms to SONIA is an important milestone in the Bank’s delivery of improvements to the resilience and effectiveness of financial markets. The reforms improve the sustainability and representativeness of this key piece of the sterling market infrastructure.”
Sir Dave Ramsden (Deputy Governor for Markets and Banking, Bank of England)
What is SOFR?
The U.S. Federal Reserve formed an Alternative Reference Rates Committee (“ARRC”) of financial institutions and regulators to identify alternative, transaction-based reference interest rates to replace USD LIBOR.
In June 2017, the ARRC selected a new (then unpublished) overnight “broad Treasuries repo financing rate,” based on transaction-level data from certain tri-party and bilateral repo clearing platforms as the preferred successor to the USD LIBOR, named “Secured Overnight Financing Rate” or “SOFR”. The Federal Reserve Bank of New York began publishing SOFR in April 2018.
Recognising that market participants cannot be expected to choose or transition cash products to a benchmark that does not have at least a threshold level of liquidity in the derivatives market, the ARRC has been promoting the development of products referencing SOFR.
That initiative has resulted in:
- Various exchanges and clearinghouses listing one- and three-month SOFR futures contracts
- The emergence of over-the-counter SOFR versus Fed Funds basis swaps
- On 30 July 2018, the rating agency Standard & Poor’s announcing that SOFR has been classified as an “anchor money market reference rate” in its principal stability fund ratings (PSFR) methodology.