Some of us recall, when in July of 2017, Andrew Bailey, Chairman of the FCA, gave a speech on the future of Libor. In the speech, Bailey expressed that, “Work must begin in earnest on planning the transition to alternative reference rates that are based firmly on transactions.” This day marked the kick-off the Libor transition.
Fast forward a couple of years later, and here we are. Timelines have already been put into place for the transition away from Libor and, for many regions, new benchmark rates have been chosen. It’s safe to say that the industry is in a good spot readying for the end of Libor. But for individual firms, the challenges of switching over to the new risk-free-rates (RFR’s) still exist.
SONIA in the UK
In the UK, SONIA has been selected as the alternative benchmark. SONIA has been around for some time and is at this point well-established. However, the biggest challenge with SONIA is that it is a forward-looking term rate, whereas Libor is backward-looking. Thus, there are marked differences in how SONIA will be handled. Firms will need to prepare their workflow, technologies and processes to cope with this change.
Interestingly, we are now seeing steps made towards making the SONIA benchmark more robust on a forward basis. So, we can build forward curves and apply forward rates for compounded SONIA. Then we can use those as the new floating rate benchmarks in derivatives and cash products, such as bonds and loans.
SONIA: An even better benchmark?
In our video above, FINCAD’s Jonathan Rosen, PhD, discusses more about the transition to SONIA. He also explains why SONIA has the right properties to replace Libor and potentially be an even better benchmark rate.
To read more on this topic, check out our related blog: Exploring the Challenges of the €STR, SOFR and SONIA Transition