Global Alternative Reference Rates

Written by Kelly Bailey

Reviewed by Jeff Schmidt

Read Time 6 minutes

What is an Alternative Reference Rate?

An alternative reference rate (ARR) is a standard reference rate used to price financial instruments, such as bonds, derivatives, and other securitized financial instruments. Alternative reference rates provide more transparent and reliable benchmarks and replacements for historical benchmarks like LIBOR.

This guide covers five of the most widely used alternative reference rates:

SOFR (USD): Secured Overnight Financing Rate
€STR (EUR): Euro Short-Term Rate
SONIA (GBP): Sterling Overnight Interbank Average Rate
SARON (CHF): Swiss Average Rate Overnight
TONAR (JPY): Tokyo Overnight Average Rate

Global Alternative Reference Rates - TONAR (Tokyo Overnight Average Rate)

Key Highlights

An alternative reference rate is a benchmark interest rate used to price floating-rate loans, derivatives, bonds, and other securitized financial instruments.

Alternative reference rates reflect actual overnight transactions and are viewed as more stable and transparent than historical benchmarks like LIBOR.

Finance professionals use ARRs in valuing bonds and derivatives, hedging certain securities, calculating discounted cash flow, and forecasting interest expenses.

SOFR (Secured Overnight Financing Rate)

The Secured Overnight Financing Rate (SOFR) is a benchmark interest rate used for U.S. dollar-denominated loans and derivatives. It reflects the cost of borrowing cash overnight when the loan is collateralized (or “secured”) by U.S. Treasury securities.

SOFR is based on actual transactions in the U.S. Treasury repurchase (repo) market, where banks and investors borrow and lend cash overnight in exchange for Treasury securities as collateral. Key features of SOFR include:

Collateralized by U.S. Treasuries, making it nearly risk-free.
Transaction-based, derived from about $1 trillion in daily repo trades.
Overnight rate, but it can be compounded or averaged to create term rates for longer periods (e.g., 1-month or 3-month SOFR).
Widely adopted, now the primary benchmark for U.S. dollar derivatives, floating-rate loans, bonds, and other financial products.

Because SOFR is based on a large volume of real, observed trades, it is a more reliable and transparent benchmark than its predecessor, LIBOR.

SONIA (Sterling Overnight Index Average)

The Sterling Overnight Interbank Average Rate (SONIA) is a benchmark interest rate used for loans and derivatives priced in pound sterling (GBP). It reflects the cost of borrowing cash overnight on an unsecured basis in the wholesale sterling market.

SONIA is based on actual transactions in the overnight unsecured money market, where banks and other financial institutions borrow and lend cash in sterling without collateral. Originally introduced in 1997, SONIA was reformed in 2018 to broaden its coverage and improve its robustness. It has since replaced GBP LIBOR as the primary benchmark rate for sterling markets.

Key features of SONIA:

Unsecured transactions, covering overnight borrowing without collateral.
Transaction-based, calculated from data on wholesale sterling borrowing collected and published by the Bank of England.
Overnight rate, but compounded SONIA is widely used to create term structures for financial contracts.
Widely adopted, now the standard benchmark for GBP-denominated derivatives, floating-rate loans, and bonds.

€STR (Euro Short-Term Rate)

The Euro Short-Term Rate (€STR) is a benchmark interest rate used for euro-denominated loans and derivatives. It reflects the cost of borrowing cash overnight on an unsecured basis within the euro area’s wholesale banking market.

€STR is based on actual transactions reported by European banks, where financial institutions borrow and lend cash overnight without collateral. Because it relies on observed market data, €STR is designed to be a robust and transparent replacement for the Euro Overnight Index Average (EONIA), which was discontinued in 2022.

Key features of €STR:

Unsecured transactions, meaning no collateral is posted for the overnight borrowing.
Transaction-based, calculated from data on overnight wholesale euro borrowing reported by banks to the European Central Bank (ECB).
Overnight rate, but compounded or averaged €STR can be used to derive term structures for longer periods.
Widely adopted, now the standard benchmark for euro-denominated derivatives, loans, and financial instruments across the eurozone.

SARON (Swiss Average Rate Overnight)

The Swiss Average Rate Overnight (SARON) is a benchmark interest rate used for Swiss franc (CHF)-denominated loans and derivatives. It reflects the cost of borrowing cash overnight when the transaction is collateralized by high-quality Swiss government securities.

SARON is based on actual transactions and quotes in the Swiss repo market, where banks and other financial institutions borrow and lend cash overnight using government bonds as collateral. SARON replaced the Swiss-franc LIBOR as the primary reference rate in Switzerland starting in 2022.

Key features of SARON:

Collateralized transactions, backed by Swiss government securities and administered by SIX Swiss Exchange.
Transaction- and quote-based, derived from actual repo trades and binding quotes in the Swiss repo market.
Overnight rate, but compounded SARON is used to generate term structures for longer maturities.
Widely adopted, now the standard benchmark for CHF-denominated derivatives, loans, and bonds.

TONAR (Tokyo Overnight Average Rate)

The Tokyo Overnight Average Rate (TONAR) is a benchmark interest rate used for Japanese yen (JPY)-denominated loans and derivatives. It reflects the cost of unsecured overnight borrowing in Japan’s interbank market.

TONAR is based on actual transactions in the Japanese overnight call market, where banks and financial institutions lend and borrow cash without collateral. Administered by the Bank of Japan, TONAR was identified as the preferred alternative to JPY LIBOR and has become the primary risk-free rate for yen markets since LIBOR’s phase-out.

Key features of TONAR:

Unsecured transactions, covering overnight borrowing without collateral.
Transaction-based, calculated from data on overnight call market trades collected by the Bank of Japan.
Overnight rate, with compounded or averaged TONAR used to support longer-term financial products.
Widely adopted, now the standard benchmark for JPY-denominated derivatives, loans, and bonds.

Global Alternative Reference Rates

What are the Similarities and Differences in Alternative Reference Rates?

Each alternative reference rate serves its specific currency market with distinct characteristics. The table below compares the five major ARRs across their key features and applications.

Alternative Reference Rates: Side-by-Side Comparison

	Full Name	Collateralized or Unsecured	Based On	Administrator	Use Cases
SOFR	Secured Overnight Financing Rate	Secured (backed by U.S. Treasuries)	Repo market transactions	Federal Reserve Bank of New York	U.S. dollar loans, bonds, and derivatives
€STR	Euro Short-Term Rate	Unsecured	Wholesale euro overnight borrowing transactions	European Central Bank (ECB)	Euro loans, bonds, and derivatives
SONIA	Sterling Overnight Interbank Average Rate	Unsecured	Sterling overnight money market transactions	Bank of England	GBP loans, bonds, and derivatives
SARON	Swiss Average Rate Overnight	Secured (backed by government securities)	Repo market transactions and quotes	SIX Swiss Exchange	CHF loans, bonds, and derivatives
TONAR	Tokyo Overnight Average Rate	Unsecured	Overnight call market transactions	Bank of Japan	JPY loans, bonds, and derivatives

Alternative reference rates are similar as they are all overnight rates based on either secured repo transactions or very short-term unsecured wholesale borrowing.

Key Features of Alternative Reference Rates

Transaction-based: Calculated from observed market transactions (e.g., repo or overnight money market deals) instead of survey submissions.
Near risk-free: Reflect little to no credit risk, especially compared to IBORs, since they are often secured or very short-term.
Overnight focus: Most ARRs are overnight rates; compounding or averaging methods are used to create term equivalents for longer maturities.
Regulator-endorsed: Chosen by central banks and working groups as the official replacements for legacy benchmarks like LIBOR.
Global adoption: Key ARRs include SOFR (U.S.), SONIA (U.K.), €STR (Eurozone), SARON (Switzerland), and TONAR (Japan).

While ARRs share common traits (transaction-based, overnight, near risk-free), they differ in a few important ways. Here are the key differences between ARRs:

Secured vs. Unsecured: Some ARRs are based on secured transactions (e.g., SOFR) Others are based on unsecured overnight lending (e.g., SONIA in the U.K.).
Credit Risk Exposure: Secured ARRs have virtually no credit risk because they’re collateralized. Unsecured ARRs carry minimal credit risk, but slightly more than secured rates.
Regional Adoption and Conventions: Each ARR is tied to its jurisdiction and currency. Conventions for compounding, averaging, and fallback mechanisms vary by region.

Why Do Alternative Reference Rates Matter to Finance Professionals?

Alternative reference rates directly impact financial decision-making across all markets. These benchmarks determine borrowing costs, derivative values, and investment returns.

Loan pricing: ARRs influence the floating interest rates applied to corporate loans, mortgages, and other debt instruments. A solid understanding helps professionals assess borrowing costs and funding strategies.
Derivatives and hedging: Many swaps, futures, and other derivatives now reference ARRs. Analysts and traders must track these rates to manage interest rate risk effectively.
Financial modeling and valuation: Analysts use benchmark rates such as SOFR or SONIA as the foundation for measuring cash flows and assessing risk.

FAQs: Global Alternative Reference Rates

What are some of the alternative reference rates that replaced LIBOR?

The most widely used ARRs are SOFR (USD), €STR (EUR), SONIA (GBP), SARON (CHF), and TONAR (JPY). Each serves as a benchmark interest rate in its respective currency area.

Which alternative reference rates are secured, and which are unsecured?

SOFR and SARON are secured rates, based on transactions backed by collateral such as government securities. €STR, SONIA, and TONAR are unsecured, reflecting borrowing without collateral.

The Bottom Line on Alternative Reference Rates

Alternative reference rates are benchmark interest rates that price floating-rate financial instruments. SOFR, €STR, SONIA, SARON, and TONAR replaced LIBOR as global standards. These rates reflect actual overnight borrowing costs in secured or unsecured markets. They provide transparent, transaction-based benchmarks for loans, bonds, and derivatives worldwide.