Sonia Reform Update



The main reasons for 2014 central bank reform of overnight rates was first to alleviate the depedence to Libor as USD $350 trillion is concentrated inside Libor Contracts. The idea was to create an alternative benchmark specific and conducive to each nation’s money markets so to drive liquidity away from Libor. Central banks created, as an alternative to Libor, overnight rates to become Risk Free Interest rates.

The second concept since adopted by all central banks is ability to create a longer dated term structure by risk free rates as alternatives to what central banks viewed as an unstable and low volume Sonia – OIS. In Sterling markets for example, the vast majority of Libor – OIS trades were short term therefore adoption of Sonia as the new risk free rate would allow longer dated trades along the term structure.

Consider Friday’s Libor OIS rate was 0.0130 vs Thursday at 0.0114 while Friday’s 3 month Libor – OIS was 0.1786. Central banks view the spread as far to wide as the net result to risk free rates is proposed to hold tigher ranges.
A bank in financial trouble under Libor contracts was considered to big to fail but as the shift away from Libor materialized then the bank may Fail safely.

The manner to hold Sonia in tighter ranges at current proposals until the final Sonia announcement in April 2018 is to employ a Trimmed Mean to the Volume weighted mean rate. Reformed Sonia is expected to then trade 1.3 basis points below current Sonia. April 2018 falls directly between March and May 2018 BOE scheduled meeting dates.

Volume will calculate at the 10th, 25th, 75th and 90th percentiles as is similar to Fed Funds by calculations at the 1st to 99th percentiles.

As an example, Sonia traded 0.2123 September 1st. As Reformed Sonia, the rate would’ve traded at 0.2014. The 10th, 25th, 75th and 90th percentiles traded from low to high at 0.15, 0.18, 0.22 and 0.23.

August 31, Sonia traded 0.2109. As reformed Sonia at 0.1946, the corresponding percentiles factor to 0.15, 0.17, 0.22 and 0.23 at the 90th percentile.

Fed Funds in comparison traded 1st to 99th percentiles Friday from 1.14, 1.16, 1.17 and 1.25 at the 99th percentile. Volume was 86 billion, down from last week’s high at 91 billion.

Expected in Sonia is far higher trading volumes to roughly GBP 40 billion daily or 52.74 billion USD. Current daily trading volumes from March to May achieved GBP 17.5 billion and the highest since Setember 2011. Interesting is actual number of trades factored to reform Sonia jumps from 341 to 357. Australia in OCR markets trades roughly 25 to 50 transactions on volume at AUD 4512.

For context, the Federal Reserve chose the secured Treasuries Funding Rate as its Libor alternative. The current rate is 1.00. The Swiss at the SNB chose Saron as its secured rate for its Libor Alternative while the Japanese chose its unsecured, uncollateralized Call rate. Saron traded Friday at minus 0.74 or 0.26. Japanese Call Rates traded Friday minus 0.041 or 0.959. The range traded minus 0.070 to 0.001. This translates to 0.93 to 0.001.

Brian Twomey

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