Sterling dealers recommend SONIA as alternative to LIBOR

Dan Barnes

The Bank of England’s Working Group on Sterling Risk-Free Reference Rates – a group of major dealers active in sterling interest rate swap markets – has announced Sterling Overnight Index Average (SONIA) as its preferred near risk-free interest rate benchmark (RFR) for use in sterling derivatives and relevant financial contracts. SONIA reflects bank and building societies’ overnight funding rates in the sterling unsecured market.

This expression of market support for SONIA will act as a platform for further work to broaden and promote its use as an alternative to sterling Libor, contributing to an improvement in the resilience of the financial system.

The announcement marks a key step in the interest rate benchmark reform agenda laid out by the Financial Stability Board (FSB) in 2014. Following cases of attempted manipulation and false reporting of global reference rates, the FSB recommended – alongside the reform of existing benchmarks including LIBOR – the development and adoption of alternative near risk-free benchmarks.

In the UK the Working Group on Sterling Risk Free Reference Rates was set up by the Bank of England in 2015 to take this work forward. The group is market-led, comprising major sterling swap dealers, reflecting the need for an RFR with broad market support. The International Swaps and Derivatives Association and clearing house LCH participate as observers to provide relevant technical advice. The Bank and the Financial Conduct Authority participate as non-voting members.

Following its meeting on 7 April 2017, each member firm of the working group voted on its preferred RFR, choosing between three candidates: SONIA, Sterling Secured Overnight Executed Transactions and the Sterling Repo Index Rate. All three candidates are based on transaction volumes and measure overnight interest rates that are considered close to risk-free. The working group’s recommendation will be subject to a broad market consultation to be held in the middle of 2017.

Chris Salmon, Bank of England executive director for Markets, said, “This is an important milestone in the benchmark reform process outlined by the FSB. Work must now begin on planning for the widespread adoption of SONIA, in consultation with a broader set of market participants. This will lead to more effective interest rate hedging markets for end-users, while minimising opportunities for misconduct.”