SONIA

The SONIA (Sterling Overnight Index Average) is a benchmark interest rate that measures the cost of overnight unsecured borrowing in sterling (British pounds). Calculated as a volume-weighted average of actual overnight lending transactions, SONIA is more reliable than its panel-based predecessor and has become the Bank of England’s preferred replacement for GBP LIBOR.

History and reform

SONIA has a long history—the Bank of England began publishing it in 1997 as a volume-weighted average of actual overnight lending transactions. Unlike LIBOR, SONIA was never based on panel estimates. It was always calculated from real trades.

However, the overnight sterling lending market was thin in the early 2000s, meaning SONIA was based on relatively few transactions. The Bank of England expanded the data sources in 2020 to include more transaction types and participants, making SONIA more robust and reliable. This reformed SONIA became the official replacement for GBP LIBOR.

How SONIA is calculated

The Bank of England collects data on sterling overnight unsecured lending transactions from major banks and financial institutions. Each transaction is recorded with its volume and rate. At the end of each day, the Bank of England calculates the volume-weighted median rate—the rate at which half the dollar volume traded above and below.

The result is published the next morning as SONIA. Because SONIA is based on observed transactions, not estimates, it cannot be manipulated. A bank cannot move SONIA by submitting a false rate; SONIA is determined by what actually traded.

Advantages and challenges

SONIA has several advantages:

• Transparency. It is based on real transactions, not guesses.
• Reliability. It reflects actual market conditions and credit risk in overnight lending.
• Long history. SONIA has been published (in some form) since 1997, allowing historical comparison.

The main challenge is that the sterling overnight unsecured lending market is relatively small compared to other sterling credit markets. On some days, there are few transactions, so SONIA can be volatile. To address this, the Bank of England allows rolling-period SONIAs (e.g., 30-day SONIA) to be calculated for longer-dated instruments.

GBP LIBOR’s replacement

GBP LIBOR was permanently discontinued at the end of 2021 (with a brief extension to 2023 for some legacy contracts). SONIA is now the primary reference rate for sterling floating-rate instruments. The transition from GBP LIBOR to SONIA involved:

• Writing new contracts in SONIA instead of LIBOR.
• Amending or refinancing legacy LIBOR contracts to reference SONIA.
• Dealing with basis risk—the spread between SONIA and LIBOR (which reflected credit risk in unsecured interbank lending) is not constant and must be managed in transition.

Rate relationships

SONIA is typically lower than GBP LIBOR was, because SONIA measures the cost of borrowing in the overnight unsecured market (lower credit risk than LIBOR, which implied a wider, riskier market). The spread between SONIA and GBP LIBOR varied over time, reflecting credit conditions and bank balance sheets.

In the years since LIBOR’s discontinuation, the financial markets have adapted to SONIA as the standard, and the transition has been relatively smooth in sterling.

See also