LIBOR: what next for sterling?

By Milain Thakkar

Major reform is already underway in the search for a LIBOR replacement with the Swiss, UK and the US leading the charge. The intention is clear but what we don't know at this stage is whether we’ll be migrating from one small single set of benchmarks to another. We believe that due to commercial and systemic risk reasons the more likely outcome is that a number of benchmarks may develop, which will require an active derivatives market for hedging risk.

To address this and to support the need to preserve capital, a view shared by banks alike, we’ve been developing a Sterling Overnight Index Average (SONIA) futures contract, to be listed on LSEDM and cleared at LCH, one of the largest clearers of SONIA swap contracts. This will support financial reform whilst allowing users to benefit from potential capital efficiencies.

Our decision to introduce SONIA futures follows the Bank of England’s (BoE) previously-announced plans to reform the Sterling Overnight Index Average (SONIA) benchmark. These reforms will be effective from the 23 April 2018 and as a result:

  • SONIA will now be calculated as the volume-weighted mean rate, based on the central 50% of the volume-weighted distribution of rates.
  • SONIA will be expanded to include bilateral as well as brokered trades. Trades must still be over £25m in size.

The Bank of England has said that these changes make the calculated rate more representative of the underlying market - seeking to remedy one of the more notable shortcomings of the current LIBOR framework with respect to reference rates. In April 2017, the Working Group on Sterling Risk-Free Reference Rates announced SONIA as the preferred near risk-free (RFR) interest rate benchmark for use in sterling derivatives and relevant financial contracts.

A global issue

We believe that by aligning its offering with the needs of market participants and regulators alike, CurveGlobal has the best chance of building organic liquidity in SONIA Futures. Benchmark reform is a global phenomenon, so why stop at just SONIA Futures? We’re already seeing:

  • US markets pushing forward with the Secured Overnight Funding Rate (SOFR);
  • The ECB announce that it wants to develop a Euro unsecured overnight rate; and
  • Switzerland moving away from their current reference rate Tom -next Overnight Index Swap (TOIS) to the Swiss Average Rate Overnight (SARON), with TOIS due to cease being published on 29 December 2017.

With regulators across the world addressing the issue of benchmarks, many questions still remain but one area in which there is universal agreement is that, for reform to take hold in a meaningful way, it is imperative that a liquid and active futures market is established. That’s why CurveGlobal is playing its part to bring competition and choice to the market.