Working Group on Sterling Risk-Free Rates Publishes Discussion Paper on SONIA Referencing Conventions

The Working Group on Sterling Risk-Free Rates has published a discussion paper aimed at raising awareness for market participants of the conventions for referencing SONIA in new financial contracts. The paper focuses on the most significant conventions for contracts that reference SONIA directly. The paper concludes with a series of questions for market participants, who should submit responses by April 30, 2019.

The Bank of England administers SONIA. It is published for a given day on the following day, on the basis of rates paid on overnight unsecured deposit transactions and is therefore only available for overnight tenors. In order to calculate SONIA for a financial contract with a tenor longer than overnight, SONIA rates have, to date, been aggregated or averaged in order to determine the interest rate payable. The interest rate is therefore only known at the end of the interest period.

The use of SONIA is increasing across asset classes but certain markets, including the loan market, lag behind. The paper sets out considerations for market conventions aimed at market participants interested in developing new SONIA based products. The paper considers:

• compound versus simple averaging (i.e. applying a simple arithmetic average to the daily SONIA rates) to determine the appropriate rates for a term contract;
• publication of a "screen rate" for SONIA by a third party to provide validation to interest calculations;
• the appropriate method for calculating margin in SONIA-referencing contracts;
• how to provide market participants with certainty regarding interest rates, via the incorporation of either a "lag" (i.e. a time delay between the SONIA rate reference period and the date interest payments are due) or a "lock out" (whereby a daily rate is repeated for the final few days of the interest rate calculation);
• fallbacks for SONIA, which currently include a rate based on the Bank of England's Bank Rate to be used in the event of short-term disruption to SONIA; and
• differences in conventions between currencies.

View the Working Group's Discussion Paper.
 
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