Moving from from LIBOR to SONIA

The purpose of this post is to briefly surmise LIBOR and its history, explain why a transition to SONIA is taking place and briefly introduce SONIA.

The London Interbank Offered Rate is a benchmark interest rate at which major global banks lend to each other in the international inter-bank market for short-term loans. It indicates the borrowing costs between banks and is calculated and published by the Intercontinental Exchange (AKA ICE)

It is based on the following currencies: USD, GBP, EUR, JPY and CHf
It is available on different maturities: overnight / spot / next / one week / one month / two months / three months / six months / twelve months
The combination of those five currencies and seven different maturities leads to a product of 35 different LIBOR rates being calculated and reported each business day. The typical quoted rate is the 3m U.S. dollar rate - commonly known as the current LIBOR rate

LIBOR is calculated by the ICE through a trimmed means approach - 16 major banks are asked how much they would charge other banks for short-term loans. Once received, the associations trims the mean by eliminating values in the upper and lower quartile and then takes the average of these remaining values to give the LIBOR rate.

LIBOR is also typically utilized as a standard gauge of market expectations of interest rates finalized by central banks, it accounts for the liquidity premiums for various instruments and serves as an indicator for the health of the overall banking system. A lot of derivative products are created, launched and traded in reference to LIBOR. It can also be used as a reference rate for other standard processes like clearing, price discovery and product valuation.
The British Banking Association estimates that LIBOR is used to rate a staggering $360 trillion of financial instruments across the globe. These instruments capture a plethora of financial products as it is a key point of reference for instruments that include: futures contracts, the U.S. dollar, and interest rate swaps.

Hybrid products such as collateralised debt obligations, collateralised mortgage obligations and a wide variety of accrual notes, callable notes and perpetual notes are also effected.

Commercial products like floating rate certificate of deposits and notes, variable rate mortgages and syndicated loans.

Major banks colluded to manipulate the LIBOR rate by taking traders requests into account and submitted artificially lower LIBOR rates to keep them at their preferred levels. This would boost traders profits who held positions in LIBOR based financial securities.
Banks also submitted false interest rates to give the impression they were more creditworthy than what they actually wear thus giving false impressions of their credit risk.
Consequently, there was heavy punitive penalties put into place that affected Barclays, Rabobank, UBS, Citigroup, RBS, Deutsche Bank, JP Morgan and Lloyds Banking Group.
It also catalysed the movement of LIBOR towards Risk Free Rates. For the UK this is likely to be SONIA.

What is SONIA?

SONIA (Sterling OverNight Interbank Average rate) is based on actual transactions and reflects the average of interest rates that banks pay to borrow sterling overnight from other financial institutions. It therefore reflects the reality of transactions in the inter-banking market and removes any chances of banks manipulating the rate through artificial pricing.
This is calculated by:

Banks would send all of their transactions by 07:00 (criteria is: >25m, unsecured & one day maturity)
The data would be checked for plausibility
SONIA and other stats would then be calculated (SONIA will be calculated using a trimmed mean approach)
SONIA would be published at 09:00

SONIA is used to value £30 trillion of assets each year
Some examples include the interest paid on swap transactions and sterling floatin grate notes

in essence anything LIBOR was used for would probably transition to SONIA - at least within sterling markets.

The Vegvisir