What Is Sterling Overnight Interbank Average Rate (SONIA)?

What Is the Sterling Overnight Interbank Average Rate (SONIA)?

The Sterling Overnight Index Average, abbreviated SONIA, is the effective overnight interest rate paid by banks for unsecured transactions in the British sterling market. It is used for overnight funding for trades that occur in off-hours and represents the depth of overnight business in the marketplace.

The Sterling Overnight Interbank Average Rate provides traders and financial institutions with an alternative to the London Interbank Offered Rate, or LIBOR, as a benchmark interest rate for short-term financial transactions.

Key Takeaways

  • The Sterling Overnight Index Average, or SONIA, is an index of very short-term unsecured loans among and between U.K. financial institutions.
  • Launched in 1997, several changes made in 2017 and 2018 have led the SONIA rate to be the preferred risk-free benchmark interest rate by U.K. securities dealers.
  • This comes as the LIBOR rate, and its methodology for calculation, has come under criticism for fixing and fraud.

Understanding the Sterling Overnight Interbank Average Rate

The Sterling Overnight Interbank Average Rate (SONIA) was established in 1997 by the Wholesale Markets Brokers' Association (WMBA) in Great Britain. Before the SONIA, the WMBA had no sterling overnight funding rate, which created volatility in the United Kingdom's overnight interest rates. With the creation of the SONIA came stability to overnight rates.

Calculated each business day in London, the SONIA fixing is the weighted average rate of unsecured overnight sterling transactions brokered by WMBA members. The minimum deal size for inclusion is 25 million British pounds.

The rate also encouraged the formulation of the Overnight Index Swap (OIS) market, and the Sterling Money Markets in Great Britain. SONIA is a widely used benchmark for many transactions, among which is the reference rate for the sterling Overnight Indexed Swap market.

Recent Changes to SONIA

The Bank of England (BoE) serves as the administrator for the SONIA benchmark. The Financial Conduct Authority (FCA) regulates the Wholesale Markets Brokers' Association as a calculation and publication agent. However, in April 2018, the BoE itself took over calculation and publication duties. Additionally, the Bank of England reported several changes that became valid as of April 2018:

  1. SONIA was expanded to include overnight unsecured transactions which will be negotiated bilaterally as well as those arranged via brokers. They now collect data using their Sterling Money Market data collection system.
  2. The bank uses a volume-weighted trimmed mean method for calculating the rate.
  3. The SONIA rate appears on the business day after the day the rate relates at 9 a.m. This delayed publication allows the bank to account for a higher volume of activity. 

In April 2017, the Working Group on Sterling Risk-Free Reference Rates, which is a group of active, influential dealers in the sterling interest rate swap market, announced SONIA would be it's preferred, near risk-free interest rate benchmark. This change will impact sterling derivatives and related financial contracts, and provide an alternative interest rate to the dominant London Interbank Offered Rate (LIBOR). 

To that end, the U.K.'s Financial Conduct Authority announced it would no longer require banks to submit LIBOR quotes after the year 2021. While LIBOR will continue to exist after that, its viability as a reference rate will likely be curtailed.

According to an announcement by the Federal Reserve in November 2020, banks should stop writing contracts using LIBOR by the end of 2021. The Intercontinental Exchange, the authority responsible for LIBOR, will stop publishing one week and two month LIBOR after December 31, 2021. All contracts using LIBOR must be wrapped up by June 30, 2023.

Article Sources
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  1. BNY Mellon. "Preparing for Benchmark Rate Reform."

  2. Intercontinental Exchange. "LIBOR®."