Sterling Overnight Interbank Average Rate (SONIA)
Candlefocus EditorSONIA represents the cost of unsecured overnight borrowing between banks in the United Kingdom and it is also used to calculate interest owed on various products, including loans and bonds. Specifically, it's an index of very short-term unsecured loans and swaps between U.K. financial institutions and it is used as the preferred benchmark for overnight borrowing and lending information in the U.K. market. Banks in the U.K. typically borrow and lend among themselves in order to fulfill their reserve requirements and fund their activities, and the overnight rate charged or received is used to account for this lending activity.
The Sterling Overnight Index Average acts as a true risk-free reference rate and is based on actual overnight transactions in the Sterling market. It is determined through a sample of actual transactions, which are anonymized, weighted, controlled and verified by the Bank of England. The daily rate is the simple average of all overnight transactions and is published at 8:45 a.m. each morning.
In 2017 and 2018, the Bank of England made several changes to the methodology and choice of participants to ensure SONIA's role as a reliable reference rate in the U.K. This includes increasing the number of participants as well as allowing externally sourced contributions to the calculations instead of relying only on internal measures. This has caused SONIA to become the preferred rate by U.K. securities dealers as the Alternative Reference Rate Committee (ARRC) in the U.S. has recommended the SONIA rate as the main alternative to LIBOR.
The Bank of England’s recent reforms to the SONIA methodology have improved its reliability. Additionally, it is looked upon more favorably than LIBOR as it is more transparent and easier to understand. Although both the LIBOR and SONIA reference rates are based on unsecured overnight financing, SONIA is determined as an arithmetic average of actual transactions as opposed to LIBOR which is based on a panel of banks’ assessment of the rates they could borrow. This increased transparency of SONIA compared to LIBOR provides an additional layer of assurance to those using it.
Overall, the Sterling Overnight Index Average is a U.K. risk-free reference rate used to calculate interest rates on various products such as loans, bonds, and derivatives. It is determined through a sample of actual transactions, weighted and controlled by the Bank of England and is becoming the preferred benchmark interest rate in the U.K. due to reforms and increasing criticism of the LIBOR rate.