BoE plans could force change to Libor-Sonia swap payments

Reformed Sonia proposals may see floating-leg settlements delayed

Bank of England: proposals would shift Sonia's publication date

Proposed changes to the sterling overnight indexed average (Sonia) rate could require a change to the payment date for swaps with floating legs referencing the benchmark, but the market is divided over which date to use.

A Bank of England (BoE) consultation paper on the proposed changes to the Sonia benchmark, which the bank says is used for pricing derivatives worth a notional of £7.7 trillion ($9.5 trillion), was released last week. The BoE's proposals, which were first outlined in 2015, include provisions to broaden the data used to formulate the benchmark to include bilateral trades as well as those arranged via brokers.

Under the new methodology it would no longer be possible to publish the rate shortly after the close of each trading day. Instead, publication would be deferred to the morning of the following business day.

This raises questions around the timing of payments of the floating legs of Libor-Sonia swaps. Currently, the rate is published at 6pm the day before the contract's end date, known as end date –1, and the floating legs are paid the next day, known as end date +0.

A senior London-based banker close to the discussions says that settlement of the floating payments could continue to be made on end date +0. But that might be too short a timeframe for certain market participants. Traders in Asia-Pacific, for instance, would not receive the rate until late on end date +0 and would be required to settle their leg almost immediately. Sterling forward rate agreements are settled in this manner and are "almost impossible" to manage in the region, he says.

"[Libor-Sonia] could still settle on the end date but it would be a bit of a rush. They would publish at 9am London time and you've got to settle it that day. Sterling Libor is published at 11.30am, so it is even later," he adds.

The other option, he says, would be to move payment of the floating leg in line with Libor-Eonia swaps, where the legs are paid on the day after the contract's end date. Libor-federal funds swap legs are paid two days after the end date but use a different rate-setting structure that some believe is unsuitable for the UK market.

The BoE consultation paper notes that the International Swaps and Derivatives Association's Rates Market Infrastructure Group has been considering this issue but is currently split on which date to use. The paper says Isda anticipates a consensus being reached prior to implementation of the change. Isda declined to comment.

The banker says that if the Sonia leg's payment date was moved, payment of the Libor leg, which is currently made on end date +0, would also have to be shifted.

"You ought to do the same on the Libor leg to keep them consistent with one another, otherwise you would get credit risk in the sense that you've got coupons flying and then flying back the next day," he says.

The BoE consultation also notes that the proposed delay to the publication of reformed Sonia could affect clearing houses, which pay interest on received margin – known as price alignment interest (PAI) – based on overnight indexed swap rates.

"Specifically, it will no longer be possible to use a given day's Sonia as an input at the current point of the calculation of the PAI to be exchanged in respect of that day," it states.

However, the paper says LCH has indicated that "this situation is not without precedent and there are a number of potential solutions." It adds that the clearing house will need to consult with its members but is confident it will have a solution in time.

LCH declined to comment.