Introduction to SONIA

and €STR

Updated as of December 16, 2020

Background

2

Global Reform

Unlike other regulatory changes with defined rulemaking – IBOR transition is about changes to market structure and liquidity.

Regulators are asking the market to adapt to the transition before any rules or guidelines are available.

Jurisdictional nuance – some jurisdictions are multi-rate and RFRs will vary by jurisdiction; different administrators and different timelines for

cessation.

Why is this Different than other Regulatory Reforms?

The Interbank Offered Rates (IBORs) have been a crucial element of the global financial services industry for more than 40 years.

Transition working groups have been established in all major jurisdictions with each group selecting their own preferred alternative to their

currency’s IBOR (some jurisdictions are moving faster than others).

The Financial Conduct Authority (FCA) plays a key international role as the regulator of ICE Benchmark Administrator which in turn is LIBOR’s

administrator.

All IBORs under FCA’s purview are slated to be replaced by RFRs; local benchmarks like CDOR and EURIBOR are also poised to be reformed to

comply with the International Organization of Securities Commissions (IOSCO) benchmark standards and will exist in parallel with their respective

RFRs until further notice.

Alternative Risk-Free Rates by Jurisdiction

Jurisdiction Old Benchmark RFR Secured/

Unsecured Underlying Asset Publication Date

UK GBP LIBOR SONIA Unsecured Money

Markets/Deposits

April 2016 (Reformed as of April 23, 2018)

US USD LIBOR SOFR Secured Repos Published as of April 3, 2018

Euro Area EURIBOR,

EONIA,

EUR LIBOR

€STR Unsecured Money

Markets/Deposits

Published as of October 2, 2019

SUI CHF LIBOR SARON Secured Repos Published as of August 25, 2009

JPN JPY LIBOR TONAR Unsecured Money Markets Published late 2016

CAN CDOR Enhanced CORRA Secured Repos Published as of June 15, 2020

Industry Work Effort

Transition Timeline

Industry working groups and individual firms are preparing and executing their transition plans and will likely continue to do so into 2022. Key industry work includes:

Q2 ‘21

CCPs to no longer accept

new swap contracts for

clearing with EFFR as PAI

and discounting.

DEC 31 ‘21

FCA will no longer compel

panel banks to submit

LIBOR quotes.

2020 2021 2022/2023 Past Milestones

DEC 31 ‘21

EMMI to cease publication of

EONIA rates.

€ RFR Working Group

recommends firms introduce

fallback language before

Dec. 31, 2021

OCT 16 ‘20

LCH Limited and CME

Group plan to move

SOFR discounting on

all USD denominated

SwapClear contracts.

Q3 ‘20

By the end of Q3 2020 lenders

should be in a position to offer

non-LIBOR linked products to

their customers.

2H ‘20

IASB published guidance on

hedge accounting treatment

of loans, bonds & derivatives.

SEPT 30 ‘20

Hardwired fallbacks incorporated in

business loans and student loans.

Develop resource guides to support market

participants’ efforts to develop consumer

education and outreach.

Target cessation for new applications for

close-end residential mortgages using USD

LIBOR and maturing after 2021.

Business and consumer loans technology/

operations vendors to be ready to transact

SOFR.

APR 01 ‘21

BoE will increase haircuts

on LIBOR-linked pre-

positioned collateral.

OCT ‘20

FSB published report on

LIBOR transition

progress.

OCT 23 ’20

Publication of revised 2006 ISDA

Definitions and protocols with new

IBOR fallback provisions.

End Q1 ‘21

Cease all new issuance

of sterling LIBOR-

referencing loan

products that expire

after the end of 2021.

JAN 25 ‘21

IBOR Fallbacks Supplement to the 2006 ISDA

Definitions and the ISDA 2020 IBOR Fallbacks

Protocol will take effect on January 25, 2021

H1 ‘21

Forward-looking term SOFR

rate to be published.

JAN 1 ‘21

GSEs will no longer

purchase LIBOR-

indexed ARMs.

DEC 31 ‘20

Target for cessation of new use of

USD LIBOR for FRNs.

Securitizations technology/

operations vendors to be ready to

transact SOFR

JUNE 30 ‘21

Target for cessation of new

use of USD LIBOR for

business loans,

securitization and

derivatives.

SEPT 30 ‘21

Target for cessation of new

use of USD LIBOR for

CLOs.

Q1 ‘21

Expected UK FCA

announcement regarding

the end of LIBOR

End Q4 ‘20

Forward looking term

versions of SONIA to be

available in the loan

market.

3

MAY 17 ‘21

Refinitiv, CDOR’s

administrator, will cease

publishing the 6 and 12

month tenors as of May

17th, 2021.

JUNE 30 ‘23

IBA target to cease the

publication of overnight and

one-, three-, six- and 12-

month USD LIBOR

DEC 31 ‘21

IBA target to cease

the publication of

GBP, EUR, CHF,

JPY LIBOR, as well

as one-week and

two-month USD

LIBOR.

SONIA Introduction

4

Sterling Overnight Index Average (SONIA)

In April 2017 the Working Group on Sterling Risk-Free Reference Rates, commissioned by the Bank of England (BoE), recommended that

SONIA is to be the successor RFR to GBP LIBOR.

SONIA is the weighted trimmed mean based on the middle 50% of all unsecured overnight sterling money market transactions brokered in

London by Wholesale Markets Brokers’ Association and is administered by the BoE.

Top and bottom 25% of transactions are trimmed.

SONIA is used to value around £30 trillion of assets each year. 1

The daily volumes underpinning the SONIA rate averaged GBP ₤40-50 bn per day. 2

SONIA has a well-established OIS market with cleared GBP OIS in excess of £8.6 trillion. 3

The spread between SONIA and the BoE rate in the post-crisis environment can be attributed to facilitation costs imposed by large UK

banks.4

SONIA vs. BoE Base Rate Source: Bank of England, as at Nov. 2, 2020

SONIA Underlying Transaction Volume in ₤GBP bn Source: Bank of England, as at Nov. 2 2020

1,3 Source: Bank of England 2 Source: CME Group

4 Federal Reserve, Interest on Excess Reserves as a Monetary Policy Instrument: The Experience of Foreign Central Banks

0

10

20

30

40

50

60

70

Notional

-6

-4

-2

0

2

4

6

8

10

12

14

0

10

20

30

40

50

60

70

80

bp

s

bp

s

Basis SONIA BoE Base Rate

Rate Cut

Comparing GBP LIBOR with SONIA

5

Key Differences Between GBP LIBOR and SONIA

Unsecured rate

Interbank-funding market participants

(panel banks)

Consensus-based and quoted based

on expert judgment

Prone to the risk of manipulation

Forward-looking rate with a term

structure

Built-in credit component

Not durable during stressed market

conditions

Daily Average of 1.2 billion Sterling in

qualifying transactions

3M GBP LIBOR vs. Compounded SONIA 3M Source: Bank of England, Federal Reserve, BMO CM

Unsecured rate

Broad-array of Sterling money market

participants

Fully transaction-based

Low risk of manipulation

Backward looking overnight rate

Risk-free rate; historical credit

mean/median adjustment relative to

LIBOR needs to be added

Historically, may have spot volatility,

but once compounded, SONIA is more

stable than GBP LIBOR

Average transaction volume of > 40

billion Sterling per day

-0.40%

-0.20%

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

1.40%

1.60%

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

4/3/2015 9/3/2015 2/3/2016 7/3/2016 12/3/2016 5/3/2017 10/3/2017 3/3/2018 8/3/2018 1/3/2019

Bas

is, %

Rat

e, %

Basis Compounded SONIA 3M 3M GBP LIBOR BoE Base Rate

2020:

Publication of revised 2006 ISDA Definitions and protocols with

new IBOR fallback provisions.

By the end of Q3 2020 SONIA lenders should be in a position to

offer non-LIBOR linked products to their customers.

Forward looking term versions of SONIA to be available in the

loan market.

2021:

Cease new issuance of GBP LIBOR-linked cash products

maturing beyond 2021 by Q1 2021.

LIBOR production is no longer mandated by the FCA.

BoE will increase haircuts on LIBOR-linked pre-positioned

collateral.

IBA target to cease the publication of GBP and EUR LIBOR on

December 31, 2021.

Outlook for SONIA

GBP LIBOR SONIA

0.0

1.0

2.0

3.0

4.0

5.0

6.0

-

2.0

4.0

6.0

8.0

10.0

Years

No

tio

na

l Is

su

ed

Bank Government Non-Bank Financial

SSA Corporate Average Term

SONIA Bond Market

6

Bond Market Conventions

The bond market is appearing to adopt compounded SONIA with Reset – 5 days convention, also known as a “lookback”. This means

that the interest payment is known 5 days prior to the date it is due to be paid.

This differs from the OIS convention of a 1 day settlement lag.

Observation Period

Interest Period

e.g. 5

days

Payment date

Reset Date t-5

(SONIA Compounded

in Arrears)

Coupon start

date

Also known as a “lookback”.

The observation period begins and ends 5

days prior to the interest accrual period.

Slightly increased interest rate risk due to

changes in the yield curve over the lifetime of

the product. It can be hedged if required.

SONIA Issuance (in GBP bn, as at Nov. 30, 2020)

Source: Bloomberg

November saw GBP£ 1.2B of SONIA issuances.

Total SONIA issuance is at GBP£ 61B with 52B

currently outstanding.

Banks continue to be the largest issuers of SONIA-

linked notes.

Derivatives

SONIA swap volumes in November were flat MoM at

USD$ 1T.

.01

1 0.5

1

.01

1.3 1

9.3

.6

3

2.2

1.2

SONIA Market Conventions

7

How Does It Work? Business Implications Technology Implications Process

Forward Looking SONIA

Term Rate (currently in progress and is the

industry preference)

Similar to current LIBOR

Minimal change

− Cost of funds

− Hedge ability

Minimal change

− Referencing new rate

− Similar functionality to

current LIBOR accrual

Minimal change

− Potential change in interest

periods

SONIA Compounded in

Arrears (ISDA’s method for derivatives;

an option for cash products)

SONIA is compounded

daily. If the observation

period is the same as

the interest period; may

require lockout

Significant change

− Accrual

− Cashflow changes

− Cost of funds impact

Most hedgeable / aligns

with current derivatives

conventions

Significant change

− Referencing new rate

− Accrual calculations

− Compounding period /

lockout / look back

− Primary / secondary

delayed compensation

Changes to risk / finance

models

Significant change

− Documentation changes

− Closing / servicing process

moving from forward to

backward looking process

− Finance process

− Increase in communications

and notifications amongst

parties

SONIA Compounded in

Advance (an option for cash products)

SONIA is compounded

daily but the observation

period is prior to the

interest period; rate is

known in advance

Minimal change

− Cost of funds

− Hedge ability

Minimal change

− Referencing new rate

− Similar functionality to

current LIBOR accrual

Minimal change

− Potential change in interest

periods

Daily Simple Average

SONIA in Arrears (an option for cash products)

Daily SONIA is averaged

over the tenor

Minimal change

− Cost of funds

Minimal change

− Referencing new rate

− Similar functionality to

current PRIME / LIBOR

accrual

Moderate change

− Documentation changes

− Interest payment dates

− Increase in communications

and notifications amongst

loan parties

− Closing / servicing process

moving from forward to

backward looking process

Interest Calculation Options

Compounding in Arrears Deep-Dive

8

Compounding in Arrears Options (Derivatives and Cash Products)

Payment Delay

(SONIA Compounded

in Arrears)

Lockout Period

(SONIA Compounded

in Arrears)

The payment date is 5 days after the end of

the observation period and interest accrual

period.

Mismatch of cash flows and increased credit

risk due to the last interest payment being after

payback of notional (incl. release of collateral).

The observed SONIA rate 5 days prior to the

payment date is held constant for the

remainder of the interest accrual period.

Slightly increased interest rate risk due to rate

changes during lockout period which can be

hedged if required.

Reset Date t-5

(SONIA Compounded

in Arrears)

The observation period begins and ends 5

days prior to the interest accrual period.

Slightly increased interest rate risk due to

changes in the yield curve over the lifetime of

the product. It can be hedged if required.

Observation Period

Interest Period

e.g. 5

days

Payment

date

Observation Period

Interest Period

e.g. 5

days

Payment date

Observation Period

Interest Period

e.g. 5

days

Payment date

Cash management and capital planning implications as payment is not known at the beginning of the period.

Similarly, changing payment dates could introduce breaks in cash-flow hedging.

Some clients may face challenges accommodating “daily fixing” in their accounting systems.

Clients (borrowers) that depend on the dealer to provide billing advice well in advance of the payment date may also face challenges.

ISDA has indicated that the compounding in arrears will be the convention however, there is an ongoing effort to create term

SONIA.

Compounding in Arrears Considerations

Source: BMO CM, SNB

Compounding in Advance Deep-Dive

9

Compounding in Advance Options (Cash Products)

Interest Period Shift

(SONIA Compounded

in Advance)

The observation period is prior the interest

accrual period.

Client knows cash flows at the start of each

interest period.

Due to the period shift cash flows of swap and

loan have a mismatch, which increases

hedging complexity.

Observation Period t-1

Interest Period t0 Payment date

SOFR

comp. (t-1)

SONIA or X days of SONIA compounded are

fixed for the whole interest period and paid at

the end.

Client knows cash flows at the start of each

interest period.

Bank takes interest rate risk.

If not compounded, SOFR may be more

volatile.

t0

Interest Period t1

Payment date

SOFR

comp. (t-1)

t-1

Interest Period t0

t1

Short Period

(SONIA Compounded

in Advance)

t0

Interest Period t1

Payment date

SOFR & +/- ∆

t-1

Interest Period t0

t1

Payment on Account

(SONIA Compounded

in Advance)

SONIA or X days of SONIA compounded are

fixed for the whole interest period and paid at

the end.

Further, a delta to compounded SONIA known

at the end of each period is paid X days after

interest period ends (by either party).

Only a part of the interest payment is known in

advance.

Source: BMO CM, SNB

US

P&BB

NA

Commercial

10

UK Industry Landscape

Sterling RFR Working Group

Established in 2015 by the Bank of England.

Membership of the group is drawn from a broad set of participants, including: banks/broker dealers, asset managers, pension funds

and insurance companies, corporates, infrastructure firms, and trade associations.

The group’s work effort has been organized in three SONIA task forces focusing on term rates, accounting treatments and

regulatory dependencies.

UK regulators and industry groups provided updated milestone timelines relating to the transition away from LIBOR across all new

sterling LIBOR linked loans :

End Q3 2020 – lenders should be in a position to offer non-LIBOR linked products to their customers;

After end Q3 2020 – clear contractual arrangements should be included in all new and re-financed LIBOR-referencing loan

products;

End Q1 2020 – all new issuance of sterling LIBOR-referencing loan products that expire after the end of 2021 should cease.

The Working Group on Sterling risk-free reference rates (WG) published their recommendations for SONIA loan market conventions

The UK government introduced the Financial Services Bill to Parliament, which provides amendments to the Benchmarks

Regulation (BMR). It provides the FCA with new and enhanced powers to oversee the orderly wind-down of critical benchmarks,

such as LIBOR

In order to ensure an orderly wind-down of the benchmark for “tough legacy” contracts, the FCA will have discretion to

determine specific categories of contracts which will be exempt from this prohibition on use.

Derivatives Market

ISDA has developed fallbacks based on the compound setting in arrears rate with the historical mean/median approach to the

spread adjustment, favored by an overwhelming majority of those who participated in the consultation.

ISDA’s IBOR Fallbacks Supplement to the 2006 ISDA Definitions and the ISDA 2020 IBOR Fallbacks Protocol launched on October

23, 2020 and will take effect on January 25, 2021

SONIA Futures Market

11

3M SONIA vs. 3M LIBOR Futures Source: Bloomberg, as at Nov. 27, 2020

Currently, ICE, CME, and CurveGlobal offer SONIA futures

trading, with the 3M being the most popular tenor.

Futures suggest that 3M SONIA will trade below LIBOR by

about 0 - 13 bps.

3M LSE SONIA futures volumes have slowed in recent months

but total monthly volumes have shown a positive trend since

being launched in May 2018.

Market Highlights

Monthly LSE Futures Volumes (Transaction data as at Oct. 30, 2020); Source: LSE

3M SONIA

Monthly CME Futures Volumes (3M SONIA as at Oct. 30, 2020); Source: CME

-0.08

-0.04

0

0.04

0.08

0.12

0.16

%

Sonia Sterling

0

4000

8000

12000

16000

20000

24000

28000

0

50000

100000

150000

200000

250000

300000

Oct Nov Dec Jan Feb Mar Apr May June July Aug Sep Oct

Op

en

In

tere

st

To

tal V

olu

me

Total Volume Open Interest

0

20000

40000

60000

80000

100000

0

20000

40000

60000

80000

100000

Op

en

In

tere

st

To

tal V

olu

me

Total Volume Open Interest

US

P&BB

NA

Commercial

12

€STR Introduction

European Short-Term Rate (€STR)

In September 2017 the ECB announced its decision to create €STR to complement existing benchmark rates and serve as the backstop

reference rate. Officially introduced and started publication from October 2, 2019.

€STR is a fully transaction-based rate which reflects the wholesale euro unsecured overnight borrowing costs of euro area banks and it is

based on existing regulatory reporting requirements (Money Market Statistical Reporting Regulation).

The rate is published for each business day based on transactions conducted and settled on the previous day and which are deemed to be

executed at arm’s length and thereby reflect market rates in an unbiased way conducted between banks and financial counterparties under

strict regulatory oversight. €STR became the basis for calculation of EONIA from October 2019 which is now calculated as €STR plus 8.5

basis points.

It is a volume-weighted average rate with the top and bottom 25% of transactions trimmed and is often referred to as “SONIA’s sister rate”.

Anticipated €STR will become more wide-spread following the CCPs discounting switch to €STR in July 2020. 1

€STR transaction volume has been fairly constant at € 30-35B per day with an occasional spike. 2

Euro Interbank Offer Rate (EURIBOR) was reformed in 2019 and will exist for the foreseeable future;

The European Money Markets Institute (EMMI) reformed EURIBOR to ensure the rate is compliant with the EU Benchmarks

Regulation and to enhance the calculation methodology to one that is anchored in transactions by following a hierarchical approach.

Reformed EONIA

1 Source: https://www.ecb.europa.eu/paym/groups/pdf/mmcg/20191203/summary.pdf 2 Source: https://externalcontent.blob.core.windows.net/pdfs/Research_ECB_291119.pdf

As of October 2 for the trade date October 1, 2019, the EMMI changed the way it calculates the EONIA.

The EONIA methodology has been redefined as the €STR plus a fixed spread, calculated using the methodology adopted by the EMMI as

the difference between the underlying interest rate of the EONIA and the pre-€STR using daily data from April 17, 2018 to April 16, 2019.

The ECB has calculated this spread as 0.085% (8.5 basis points).

Reformed EONIA and €STR were published for the first time on October 2, 2019, reflecting the trading activity of the previous day.

The Working Group on Euro RFRs recommends that market participants gradually replace the EONIA with the €STR for all products and

contracts, making the €STR their standard reference rate.

EMMI will continue to publish EONIA until December 31, 2021, the date on which the benchmark will be discontinued.

US

P&BB

NA

Commercial

13

European Working Group

Key Differences Between EURIBOR, EONIA and €STR

1 Source: European Central Bank Statistical Data Warehouse

Unsecured rate

Euro interbank-lending market

participants (panel banks)

Consensus-based and quoted based

on expert judgment

Prone to the risk of manipulation

Forward-looking rate with a term

structure

Built-in credit component

Not durable during stressed market

conditions

Daily Average of 1.2 Billion Sterling in

qualifying transactions

Unsecured rate

Same panel banks as for EURIBOR

Quotation-based, one per panel

bank

More susceptible to manipulation as

volumes decrease

Backward-looking overnight rate

Nearly risk-free

Not durable during stressed market

conditions

Average daily transaction volume of

€3.6 billion1

Administered by the private EMMI

Unsecured rate

Broader array of Euro bank participants

Fully based on deposit transactions

Low risk of manipulation; backward-

looking overnight rate

Nearly risk-free rate

Historically less volatile than EONIA;

some spot spikes but on a 3M

compounded basis it is historically less

volatile than EURIBOR

Average transaction volume of € 30-35

billion per day

Administered by the ECB

EURIBOR EONIA (pre €STR) €STR

The Working Group on Euro RFRs is an industry-led group with European regulators and the ECB serving as observers.

The groups work effort in 2019 consisted of reforming the EONIA methodology, reforming EURIBOR, launching €STR, conducing

consultations and providing market participants with guidance.

LCH completed the €STR discounting switch on be Monday July 27, 2020.

The European Commission proposes to amend the EU Benchmark Regulation (BMR) to allow EU users to continue using currency

benchmarks provided outside the EU (third country benchmarks).

The results of the July 2020 ECB consultation confirmed that a large majority of respondents were in favour of the ECB as a trusted authority

to publish compounded term rates using the €STR.

WG on Euro RFRs consults on EURIBOR fallback trigger events and on €STR-based EURIBOR fallback rates.

European Working Group Transition Updates

This material has been prepared with the assistance of employees of Bank of Montreal (“BMO”) who are involved in derivatives sales and marketing efforts.

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TO MALAYSIAN RESIDENTS: The Information contained herein is information which is publicly available. This report and the Information contained herein do not constitute nor should they be construed as an offer to sell or buy, or an inducement or solicitation of an offer to sell or buy, or a proposal in respect of, or a dealing in, any securities, currencies, derivatives or any other financial products (“financial products”) in Malaysia. Bank of Montreal and its affiliates do not represent that the Information may be lawfully distributed, or that any financial products may be lawfully offered or dealt with, in compliance with any applicable registration or other requirements in Malaysia, or pursuant to an exemption available thereunder, or assume any responsibility for facilitating any such distribution, offering or dealing in such financial instruments.

TO KOREAN RESIDENTS: This material is not provided to make a recommendation for specific Korean residents to enter into a contract for trading financial investment instruments, for investment advising, for discretionary investment, or for a trust, nor does it constitute advertisement of any financial business or financial investment instruments towards Korean residents. The material is not provided as advice on the value of financial investment instruments or any investment decision for specific Korean residents. The provision of the material does not constitute engaging in the foreign exchange business or foreign exchange brokerage business regulated under the Foreign Exchange Transactions Act of Korea.

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TO INDONESIAN RESIDENTS: No registration statement has been filed with the Financial Services Authority (Otoritas Jasa Keuangan - OJK) and no information contained herein should be considered as an offer to sell or the solicitation of an offer to buy any financial products in a manner which constitutes a public offering under the Indonesian capital market laws and regulations. BMO and its affiliates do not represent that the Information may be lawfully distributed, or that any financial products may be lawfully offered, in compliance with any applicable registration or other requirements in Indonesia, or pursuant to an exemption available thereunder, or assume any responsibility for facilitating any such distribution or offering. You are advised to exercise caution in relation to the Information contained herein. If you are in doubt about any of the content of these documents, you should obtain independent professional advice.

TO PHILIPPINE RESIDENTS: This Information is intended for distribution only to “qualified buyers” as defined under in Section 10 (l) of the Securities Regulation Code of the Philippines. The contents hereof are not intended for the use of and may not be issued or passed on to retail clients.

TO VIETNAMESE RESIDENTS: This document is not a securities offering document and is not required to be registered with any relevant authorities of Vietnam. The contents hereof are intended solely for the use of, and may only be passed on to, persons with whom BMO has had agreement on provision of the Information. The Information is not provided as advice on the value of financial investment instruments, to make a recommendation for specific Vietnamese residents to enter into a contract for trading financial investment instruments, for money broking, for asset management, for settlement and clearing services or for a trust , nor does it constitute advertisement of any financial business or financial investment instruments towards Vietnamese residents . BMO and its affiliates do not represent that the Information may be lawfully imported, distributed, or that any financial products may be lawfully offered, in Vietnam, in compliance with applicable laws of Vietnam, and do not assume any responsibility for facilitating any import, distribution or offering thereof. The Information is only for private use of recipients and may not be reproduced, distributed or published in Vietnam in any form, except under circumstances that will result in compliance with applicable laws of Vietnam.

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