As a result of the consultation on the transition from LIBOR to SONIA, the Bank of England has confirmed that it will publish a compounded SONIA index from August. Adrian Joliffe of 2TIX LTD consultancy explains how this will work in practice.
It was recognised that for some organisations, calculating daily compounded SONIA from the raw data will be daunting. The compounded index will enable borrowers to verify interest payable on a SONIA-linked loan by replacing multiple compound interest calculations with a one-step formula.
This proposal was fully supported by the NHF in their response to the consultation. What does it mean in practice?
Like any index, it is based on continuous compounding. From it you can work out the interest rate between any two dates and use this to calculate the interest payable.
In addition to the index, you will need the following information:
In the following example, the interest period is 90 days, the loan amount is £1m and the 'lag' period is five London banking days. In your calculations, you should always use the relevant index figures for 'reference period', not the interest period.
Here, the reference period has the same 90 days as the corresponding interest period but ends five London banking days earlier, which are the five days of lag.
Compounded SONIA rate = ((index from reference period end/index from reference period start) - 1) x (365/90)
Once you have calculated the Rate, interest payable is easy to calculate:
Interest payable = £1,000,000 x (90/365) x (compounded SONIA rate + margin)
To make life even easier, Abovo-Consult and 2TIX LTD have jointly published a simple calculator on the 2TIX website for you to test your calculations. You will also find a SONIA glossary to help understand the new jargon and fully worked examples for calculating accrued interest and independently verifying interest payable.
In April, and in view of the coronavirus lockdown, the Working Group on Sterling Risk-Free Reference Rates recommended a change to the timeline for LIBOR transition:
Although these timings are later than originally, the final deadline of Q4 2021 has not changed.