The Working Group on Sterling Risk-Free Reference Rates – a group of major dealers active in sterling interest rate swap markets – has today announced SONIA as its preferred near risk-free interest rate benchmark (RFR) for use in sterling derivatives and relevant financial contracts.
This expression of market support for SONIA will act as a platform for further work to broaden and promote its use as an alternative to sterling Libor, contributing to an improvement in the resilience of the financial system.
Today’s announcement marks a key step in the interest rate benchmark reform agenda laid out by the Financial Stability Board (FSB) in 2014. Following cases of attempted manipulation and false reporting of global reference rates, the FSB recommended – alongside the reform of existing benchmarks including LIBOR – the development and adoption of alternative near risk-free benchmarks.
In the UK the Working Group on Sterling Risk Free Reference Rates was set up by the Bank of England in 2015 to take this work forward. The group is market-led, comprising major sterling swap dealers, reflecting the need for an RFR with broad market support. ISDA and LCH Ltd participate as observers to provide relevant technical advice. The Bank and the Financial Conduct Authority participate as non-voting members.
Following its meeting on 7 April 2017, each member firm of the working group voted on its preferred RFR, choosing between three candidates: SONIA, £SONET, and £RIR. All three candidates are based on robust transaction volumes and measure overnight interest rates that are considered close to risk-free.
The working group’s votes have now been collated and the outcome published as part of the minutes of the group’s 7 April meeting. The decision in favour of SONIA was by more than the required two-thirds supermajority.
The selection of SONIA as the sterling RFR reflects that, on completion of the SONIA reform process currently underway, it will be a strong and credible benchmark that meets the criteria set out by the working group. The working group’s recommendation will be subject to a broad market consultation to be held in the middle of 2017.
François Jourdain, Chair of the Working Group, said: “This recommendation reflects two years of careful deliberation by the member firms and has been informed by extensive outreach to other market participants. This effort also catalysed the development of candidate RFRs, significantly enhancing the transparency of the sterling money markets and the resilience of sterling interest rate benchmarking. I would like to warmly thank the group for their hard work and thoughtful commitment.”
Chris Salmon, Bank of England Executive Director for Markets, said: “This is an important milestone in the benchmark reform process outlined by the FSB. Work must now begin on planning for the widespread adoption of SONIA, in consultation with a broader set of market participants. This will lead to more effective interest rate hedging markets for end-users, while minimising opportunities for misconduct.
“I am very grateful for the efforts of the Working Group in taking the first step on the path towards the adoption of a sterling risk-free rate as an alternative to Libor. I am particularly grateful to François Jourdain for his leadership of the group.
“I also welcome the development of the two new secured benchmarks that have emerged during this process. Having a range of benchmarks available clearly benefits the infrastructure of sterling markets.”