SONIA and SOFR Explained: Overnight Reference Rates
SONIA and SOFR are overnight benchmark interest rates used in sterling and US-dollar financial contracts, respectively. SONIA reflects eligible unsecured sterling wholesale deposits; SOFR reflects overnight US Treasury-secured financing transactions. Both are transaction-based benchmarks, but they measure different markets and are not interchangeable.
How SONIA is calculated
The Bank of England administers SONIA. Its methodology uses eligible sterling overnight wholesale unsecured deposit transactions and calculates a volume-weighted trimmed mean from the central 50% of the eligible volume-weighted distribution. The Bank publishes the rate each London business day following the relevant underlying transaction date under its stated schedule. Transaction eligibility, minimum size and calculation conventions matter. SONIA is not the Bank Rate and can differ from it due to market conditions.
How SOFR is calculated
The Federal Reserve Bank of New York administers SOFR as a broad measure of the overnight cost of financing US Treasury securities. It draws from several repo transaction segments and uses a volume-weighted median, after defined exclusions. Repo financing is secured by collateral, unlike the unsecured deposits underlying SONIA. SOFR normally appears on the New York Fed’s website on US business days. Publication conventions can differ around US holidays.
Why a benchmark differs from a policy rate
A central bank sets or targets policy-rate conditions, whereas a reference rate measures transactions in a particular money market. Market rates can diverge because of funding demand, liquidity, reserve conditions and collateral preferences. SONIA is denominated in sterling and SOFR in dollars, so an apparent numerical spread does not directly predict GBP/USD without broader exchange-rate and hedging considerations.
Worked example: daily compounding
Suppose a fictional contract accrues a 4% annualised overnight rate for 30 days under a simplifying 365-day convention with no rate changes. Its 30-day interest growth factor is approximately (1+0.04/365)^30, implying a return of about 0.329%. On a £1 million notional, that is roughly £3,293. Actual SONIA and SOFR contracts may use changing daily rates, distinct day-count conventions and observation shifts; always read the applicable documentation.
Backward-looking compounding versus forward expectations
Compounded overnight rates aggregate realised daily overnight observations over an accrual period. Term benchmark rates, where supported for a given market and product, may represent a forward-looking term structure or a different calculation. A contract referencing compounded SOFR in arrears therefore does not necessarily fix its interest amount at the start of the period. Notice periods and observation lags allow borrowers and lenders to determine the payment before settlement.
Why derivatives and loan documentation matters
Swaps, bonds and loans may specify different compounding conventions, credit adjustment spreads, floors and payment lags. An all-in corporate borrowing rate can include a lender spread on top of the benchmark. A central bank policy surprise can influence projected overnight paths and therefore swap values, but a single daily SONIA or SOFR observation does not capture the entire term structure.
A responsible comparison framework
Identify currency and secured status, administering institution, eligible transaction set, statistic and publication time. For a contract, check whether the benchmark is daily simple or compounded, the day count, observation period, floor and payment date. Avoid directly substituting the US benchmark for a sterling product solely because both represent overnight money-market rates.
Common misconceptions
Neither benchmark is a promise that a retail investor can lend at the published rate. A historical average is not a forward rate forecast. Secured and unsecured transaction markets have different credit and collateral characteristics, and the quoted rates reflect those differences. The apparent resemblance between SONIA and SOFR names conceals distinct calculation rules.
SONIA and SOFR: side-by-side reference
Both benchmarks measure overnight activity, but they differ in currency, underlying market and calculation.
| Characteristic | SONIA | SOFR |
|---|---|---|
| Currency | British pound sterling (GBP) | US dollar (USD) |
| Underlying market | Eligible unsecured overnight wholesale deposits | US Treasury-secured overnight repurchase financing |
| Administrator | Bank of England | Federal Reserve Bank of New York |
| Rate statistic | Volume-weighted trimmed mean | Volume-weighted median |
| Key caution | Not identical to Bank Rate or a guaranteed retail deposit return | Not an unsecured bank funding rate or a retail saving yield |
| Contract detail | Check compounding, day-count and observation shift | Check compounding, day-count and observation shift |
A sterling loan that pays compounded SONIA in arrears and a dollar loan that pays compounded SOFR can have broadly similar structures without referencing the same economic market. For cross-currency analysis, a simple comparison of the two printed rates ignores the FX swap market, hedging costs and basis. In a spreadsheet, record the benchmark date, observation interval, compounding and year basis before calculating cash interest; otherwise two correct individual calculations can still produce a misleading cross-market comparison.
Frequently asked questions
Is SONIA identical to Bank Rate?
No. SONIA measures eligible wholesale transactions; Bank Rate is a policy instrument.
Is SOFR unsecured?
No. It measures financing collateralised by US Treasury securities.
Why do contracts compound overnight rates?
Compounding converts a sequence of daily funding rates into an interest amount over a longer period.
Sources and further reading
Continue learning with Bond Prices and Yields in the Traders MBA Education library.