SONIA: Trading Opportunities in an Emerging Benchmark

So it is with the burgeoning market for futures referencing the Sterling Overnight Index Average (SONIA), which is set to replace LIBOR as the standard interest rate benchmark in the sterling market. It’s extremely rare for a completely new product to be launched on three venues at the same time, but with SONIA futures now available from three leading exchange operators, market participants need to be connected to all three if they are to make the most effective use of the new product and capitalise on trading and arbitrage opportunities.

Transition from LIBOR

LIBOR has been a widely-used benchmark in financial markets for many years, referenced by trillions of dollars’ worth of contracts, but its days became numbered following the weaknesses exposed by the rate rigging scandals of recent years. After extensive dialogue and consultation, an industry working group led by the Bank of England selected SONIA as the preferred risk-free rate for sterling contracts in April 2017.

UK regulators have since made clear they will no longer compel banks to continue making submissions to LIBOR after 2021, effectively setting a timeline for SONIA to replace LIBOR. But the transition to SONIA is already well under way; reforms have been made to the benchmark and a liquid market is gradually developing around it.

One-month and three-month futures contracts referencing SONIA have become available to trade at Intercontinental Exchange (ICE), CurveGlobal, and CME over the past year. While CME launched the product as recently as October, it is clear that there is already significant appetite for SONIA futures. A record daily trading volume of 4,563 contracts was reported at ICE in July, while CurveGlobal expects its new portfolio margining service to yield further efficiencies and boost volumes.

Demand for the new contract may be driven by a variety of factors, with some market participants seeking to hedge genuine exposure, while others are simply speculating or exploring the nascent market. But any active interest in SONIA futures, whether speculative or not, requires reliable connectivity to these three platforms and the ability to scale with each one.

Introducing PaaS

In re-assembling an already-fragmented market and seeking the best liquidity in SONIA futures across three venues, Platform-as-a-Service (PaaS) comes into its own. While in other asset classes, contracts may be offered in subtly different formats by different exchanges, the SONIA futures are virtually identical at CME, ICE, and CurveGlobal, and market participants can use PaaS to gauge liquidity per venue which ultimately influences where to route their flow. For some participants, there may be an arbitrage opportunity to be seized.

PaaS enables the seamless trading of SONIA futures across multiple exchanges in real time, but it is not just about low-latency connectivity and market data. The real benefit of PaaS is in allowing users to scale their activity within a particular exchange at low cost and to quickly migrate to new exchanges with a little more than a phone call.

The story does not end with SONIA, of course, as risk-free rates are set to replace existing interest rate benchmarks all over the world. The Secured Overnight Financing Rate (SOFR) is already well developed in the US, and SOFR futures are available to trade at CME, further adding to the need for PaaS.

By lowering the total cost of ownership and enabling the seamless connectivity to multiple liquidity pools, PaaS has the potential to become a vital tool to support the further development of both SONIA and SOFR futures. In short, it may be just what is needed to stitch together a fragmented but important new market and access its full depth.