4 min read

Navigating Interest Rate Benchmarks: A Guide To Understanding SOFR, ESTR, SONIA, TONAR, and the Transition from LIBOR

Navigating Interest Rate Benchmarks: A Guide To Understanding SOFR, ESTR, SONIA, TONAR, and the Transition from LIBOR

LIBOR stands for the London Interbank Offered Rate. This is a benchmark interest rate that indicates the average interest rate at which major banks can borrow from one another in the London interbank market. LIBOR is calculated for various currencies, including the U.S. Dollar (USD), British Pound Sterling (GBP), and Euro (EUR). The rates for these currencies are commonly referred to as USD LIBOR, GBP LIBOR, and EURIBOR, respectively. LIBOR, which stands for the London Interbank Offered Rate.

USD LIBOR (U.S. Dollar LIBOR):

This is the benchmark interest rate for U.S. Dollar-denominated loans and financial instruments. It is determined daily by a panel of major banks, which submit their estimated borrowing costs. USD LIBOR is widely used in financial markets as a reference rate for various financial products, including adjustable-rate mortgages, business loans, and interest-rate swaps.

GBP LIBOR (British Pound Sterling LIBOR): 

This is the benchmark interest rate for British Pound Sterling-denominated loans and financial instruments. Similar to USD LIBOR, it is determined daily based on submissions from a panel of major banks. GBP LIBOR is used as a reference rate for a range of financial products in the UK, such as loans, mortgages, and derivatives.

EURIBOR (Euro Interbank Offered Rate): 

This is the benchmark interest rate for Euro-denominated loans and financial instruments. It represents the average interest rate at which a panel of European banks can borrow from one another. Like USD LIBOR and GBP LIBOR, EURIBOR is widely used as a reference rate for Eurozone financial products, including loans, mortgages, and interest rate derivatives.

LIBOR has been phased out and replaced with the following alternative rates:

In the United States: Secured Overnight Financing Rate (SOFR)

In the United Kingdom: Sterling Overnight Index Average (SONIA)

In the Eurozone: Euro Short-Term Rate (ESTR)

In Japan: TONAR, or the Tokyo Overnight Average Rate.

Let’s look at each of these briefly:

SOFR, Or The Secured Overnight Financing Rate.

Is a benchmark interest rate that serves as an alternative to LIBOR (London Interbank Offered Rate) for U.S. Dollar-denominated transactions. SOFR is based on transactions in the U.S. Treasury repurchase agreement (repo) market, specifically on overnight, secured loans collateralized by U.S. Treasury securities. This market is considered a robust and well-defined market, providing a deep source of liquidity.

SOFR represents the cost of borrowing cash overnight using U.S. Treasury securities as collateral. Unlike LIBOR, which reflects unsecured lending among banks, SOFR is a secured rate. It is designed to serve as a key reference rate for a wide range of financial products, including floating-rate debt, derivatives, and other financial contracts.

SOFR is calculated as a volume-weighted median of transaction-level repo data, obtained from various segments of the U.S. repo market. The Federal Reserve Bank of New York publishes the SOFR rate daily, at approximately 8:00 a.m. Eastern Time.

In addition to overnight SOFR, there are discussions and efforts to develop and publish SOFR rates for other tenors (e.g., 1-month, 3-month) to accommodate various financial products that currently reference LIBOR with different maturities.

ESTR, or the Euro Short-Term Rate

This is a benchmark interest rate that serves as an alternative to LIBOR (London Interbank Offered Rate) for Euro (EUR)-denominated transactions. ESTR reflects the wholesale euro unsecured overnight borrowing costs of banks within the euro area. ESTR is based on the actual transaction data of euro-denominated unsecured overnight lending in the wholesale market. The underlying market for ESTR comprises a diverse group of banks participating in the euro money market.

Similar to other risk-free rates, such as SONIA, ESTR is based on unsecured transactions, meaning that the lending is not collateralized by specific assets. It represents the interest rate at which banks lend to each other on an unsecured basis overnight. ESTR is intended to be a key reference rate for the euro area and is used in various financial products, including derivatives, loans, and other contracts.

ESTR is calculated as a volume-weighted average of all transactions in the euro unsecured overnight market. The European Central Bank (ECB) compiles and publishes ESTR daily, reflecting the weighted average rate of the previous day's transactions. The rate is then published at 8:00 a.m. Central European Time (CET).

There have been discussions and efforts to develop additional tenors for ESTR. The extension to different tenors beyond the overnight rate is aimed at providing a reference rate for a wider range of financial products with varying maturities.

SONIA, Or The Sterling Overnight Index Average

This is a benchmark interest rate that serves as an alternative to LIBOR (London Interbank Offered Rate) for British Pound Sterling (GBP)-denominated transactions. SONIA is based on actual overnight funding transactions in the unsecured market, providing a reference rate that reflects the average interest rate at which banks lend to each other on an unsecured basis overnight. It represents a broad measure of overnight funding rates in the UK money markets.

Unlike LIBOR, which represents interbank lending with a credit risk component, SONIA is based on unsecured transactions, meaning that the lending is not collateralized by specific assets. It is widely used as a reference rate for various financial products, including floating-rate loans, derivatives, and other contracts. It is considered a key benchmark for the UK financial markets.

SONIA is calculated as a volume-weighted average of interest rates on unsecured overnight transactions, which are sourced from a broad and diverse panel of banks. The calculation includes data on actual transactions, making it a robust and transaction-based benchmark. It is typically published by the Bank of England at or around 9:00 a.m. London time on the following business day.

There have been discussions and efforts to develop additional tenors for SONIA. The extension to different tenors beyond the overnight rate is aimed at providing a reference rate for a wider range of financial products with varying maturities. In particular, the focus has been on developing forward-looking term rates based on SONIA.

TONAR, or the Tokyo Overnight Average Rate.

Is a benchmark interest rate that serves as an alternative to LIBOR (London Interbank Offered Rate) for Japanese Yen (JPY)-denominated transactions.

TONAR is considered one of the key benchmark rates for the Japanese money market and serves as a reference for various financial instruments, including short-term interest rate derivatives, loans, and other financial contracts.

TONAR is calculated as a volume-weighted average of uncollateralized overnight transactions in the Japanese money market. It reflects the average interest rate at which banks lend to each other on an unsecured basis overnight.

Visit our Academy page for similar articles like this.