Sterling Overnight Interbank Average Rate (SONIA)

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

Sterling Overnight Interbank Average Rate (SONIA) is an unsecured overnight rate for wholesale funds for all sterling-denominated unsecured overnight funding deals in the British sterling market. SONIA facilitates the direct use of overnight funding deals in financial contracts across the sterling bond, loan, and derivative markets.

SONIA serves as a benchmark interest rate for financial contracts without incorporating the credit risk premium embedded in the now-discontinued London Interbank Offered Rate (LIBOR). LIBOR was previously used across a wide range of wholesale and retail financial products, as well as in valuation, accounting, and risk models.

Sterling Overnight Interbank Average Rate Explained

SONIA was first launched in March 1997 by the Wholesale Market Brokers’ Association (WMBA). It was designed to track the rate of actual overnight funding transactions. SONIA fixing is computed as a transaction-to-volume weighted average interest in British sterling markets brokered by WMBA-member firms in London. Under the reformed methodology, SONIA is based on actual transactions in the overnight unsecured sterling market, including trades of all sizes reported by UK banks and building societies. 

SONIA was widely used in the UK markets before its selection by the Bank of England (BoE) in April 2016 as a critical benchmark for the sterling financial markets. The benchmark is based on actual transactions and factors in the actual interest rates charged for overnight borrowings.

Furthermore, it measures overnight interest rates in a way that is considered free from systematic risks. As of August 3, 2020, the BoE started calculating and publishing SONIA every day on any London business day that is not a holiday. Since its creation, there has been stability in the overnight rates in the British financial market.

SONIA replaced LIBOR as the benchmark rate for sterling markets. LIBOR’s discontinuation followed growing concerns over its reliability, as it was based on a shrinking volume of interbank lending and included a credit risk component that made it more volatile. In contrast, SONIA reflects actual overnight transactions and is viewed as more stable and transparent. 

Sterling Overnight Interbank Average Rate is already used as the benchmark for discounting sterling rates and Sterling Overnight Indexed Swaps (OIS). The Bank of England’s series of changes has strengthened SONIA as a critical benchmark for financial contracts on sterling markets. Unlike LIBOR, which was based on estimated rates from a limited number of brokered transactions, SONIA is derived from real, high-volume market activity. 

SONIA has also been adopted as the fallback rate for sterling-denominated derivatives under the International Swaps and Derivatives Association (ISDA) protocols, further reinforcing its role in post-LIBOR market infrastructure.

SONIA now reflects a wide range of scope of unsecured deposits. In line with the reformed methodology, the Bank of England reports that SONIA is based on tens of billions of pounds in overnight transactions each day, making it significantly more robust than the market that previously underpinned LIBOR.  This amount is three times as much as financial contracts recorded by LIBOR.

Overnight Markets

In general, interbank markets enable banks to provide lending and deposit facilities by pooling, managing, and redistributing funds. The overnight market is considered one of the most important interbank markets.

By providing safety valves, the market plays an important role in a country’s monetary and payment system. Banks with insufficient cash flow to balance their position at the end of a trading period are forced to borrow. On the other hand, banks with abundant cash reserves at the end of a trading period can lend money to other banks with insufficient cash flows.

Borrowing from the central banks is usually considered a last resort since it comes with a significant penalty compared to borrowing from the market. The interest rate in the overnight markets serves important functions such as shaping the monetary policy, as well as a key short-term indicator for traders.

Changes to SONIA

SONIA has been administered by the Bank of England since April 2016 and is the selected risk-free rate (RFR). In such a case, the RFR refers to a rate of return on investment with zero risk of credit loss. The Financial Conduct Authority (FCA) provides regulatory oversight of benchmark frameworks more broadly under UK Benchmark Regulation.

The following changes have been affected regarding SONIA:

• It includes bilaterally negotiated transactions, as well as brokered financial transactions.
• It includes a volume-weighted average interest rate for computing the rate.
• SONIA rate is reported on the business day and published at 9:00 a.m. The arrangement is meant to give financial institutions enough time to account for a higher volume of activities.

With LIBOR now retired, SONIA has been adopted as the official benchmark for sterling-denominated derivatives and other financial instruments. The transition was completed in March 2024, when the temporary use of synthetic GBP LIBOR was discontinued. From that point forward, all sterling contracts required active conversion or a fallback to alternative rates like SONIA.

As a near-risk-free rate based on actual transactions, SONIA offers greater transparency and has become the standard for sterling markets. 

Additional Resources

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To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

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