Alternative reference rates

The global transition to new benchmarks

As a new era for interest rate benchmarks begins, markets have been making the shift towards alternative reference rates, with implications that span the finance landscape.

LIBOR® which effectively underpinned hundreds of trillions globally in financial products, is in the process of being wound down. Regulators urged markets participants to adopt the new benchmarks and reforms have seen several LIBOR rates cease or continue in a “synthetic” form, and related contracts transition to alternative or fallback benchmarks.

The need for benchmarks to be based on overnight reference rates derived from transactions has been reinforced by global regulators, including The Financial Stability Board and the International Organization of Securities Commissions.

The industry has since moved to a raft of alternative reference rates from the AONIA (Australian Interbank Overnight Cash Rate) to SARON (Swiss Average Rate Overnight).

The U.K. - SONIA

In March 2021 the FCA confirmed that most GBP LIBOR settings would cease to be published beyond the year end.

The Sterling Overnight Interbank Average (SONIA) was chosen by the Working Group on Sterling Risk-Free Reference Rates as the U.K.’s preferred alternative reference rate.

SONIA has been a benchmark since 1997. As a transaction-based benchmark, it reflects the average interest rates that banks pay to transact sterling overnight from other financial institutions.

The Bank of England became SONIA’s administrator in 2016, and later implemented reforms to strengthen its methodology. This involved broadening SONIA’s scope of overnight unsecured deposits to help bolster underlying transaction volumes. Through 2017 and 2018 ICE listed their first futures contracts referencing SONIA, with the offering increasing to also include a full suite of Options in 2020. Volume and Open interest built steadily from launch.

In December 2021, ICE converted all outstanding open interest in Short Sterling Futures and Options to their equivalent SONIA derivatives, without issue. ICE SONIA Futures are now the dominant GBP STIRS contract.

The U.S. - SOFR

Certain USD LIBOR setting ceased at year-end 2021, but most are continuing to end-June 2023. The Secured Overnight Financing Rate (SOFR) has been recommended by the Alternative Reference Rates Committee (ARRC) as the preferred alternative reference rate.

SOFR is an overnight reference rate that broadly measures the cost of borrowing cash with U.S. Treasuries as collateral. It was introduced in 2018 by the Federal Reserve Bank of New York

The SOFR rate is published daily by the New York Fed based on data collected on over $USD800 billion in secured overnight repurchase transactions. These represent the largest underlying volumes of any U.S. money market, underscoring SOFR’s stability. Additionally, each day, the New York Fed produces SOFR averages across various terms, and an index to allow the calculation of averages over custom periods. These averages aim to further boost market confidence.

Using similar tactics to their counterparts in Europe, regulators are increasingly putting restrictions on the use of USD LIBOR, and it now seems it is a question of time for US markets to catch up and transition away from LIBOR. Supported by the SOFR First Initiative launched in July 2021, adoption of SOFR has soared in recent months. In futures, 14% of market wide Open Interest is now linked to the new rate. Swaps market have also been adapting. In recent weeks, as much as 70% of dealer to dealer activity is now benchmarked against the new rate. It is reported that in USD swaptions, 95% of new trades reference SOFR.

ICE Futures Europe offers One Month and Three Month SOFR futures, with open interest continuing to build.

Europe - Euribor and SARON

The ICE Euribor contract does not reference a EUR LIBOR rate, instead referencing the EMMI Euribor rate. EURIBOR has seen recent reform and has been deemed representative, with no confirmed plans from regulators to seek an alternative rate. Euribor futures will continue to trade as they do currently.

The FCA announced in March 2021 that the CHF LIBOR rate would cease to be published beyond the year end. The ICE Euroswiss contract referenced the 3 Month CHF LIBOR rate.

ICE launched the current version of SARON futures in January 2021, which reference the SARON rate as licensed from and administered by the SIX Swiss Exchange. SARON is a transaction-based benchmark, which represents the overnight interest rate of the secured money market for Swiss francs (CHF). It is based on transactions and quotes posted in the Swiss repo market, a pivotal part of the Swiss Value Chain.

In December 2021, ICE converted all outstanding open interest in Euroswiss Futures to their equivalent SARON derivatives, without issue. ICE SARON Futures now trade as the dominant STIR contract to trade and hedge the Swiss curve, with open interest continuing to grow.

ICE offers customers the greatest liquidity to manage U.K., European and Swiss interest rate risk as part of a broad multi-currency rate product suite. ICE’s interest rates derivatives clear through ICE Clear Europe, enabling up to 80% margin offsets depending on expiries/currencies.