SONIA & SOFR - compounding the problem with conventional wisdom?

There’s been a lot of talk recently in the Risk Free Rates (RFR) space about conventions to use for compounding calculations, and what the "right" number is.

What lies behind these questions are disagreements within the industry about which calculation conventions to use:

  • Differences in approach between asset classes (swaps v Floating Rate Notes (FRNs) loans v mortgages)
  • Differences between jurisdictions (e.g. Secured Overnight Financing Rate (SOFR) v Sterling Overnight Index Average (SONIA))

There are even differences within the same asset class and jurisdiction (SOFR FRNs have seen four different models so far - see Alternative  Reference Rates Committee’s (ARRC) Comparison Chart).  

For those less familiar with the background to all this, a good starting point is the Financial Stability Board’s (FSB)  User Guide to Risk-Free Rates (RFR).  Regulators are encouraging the market to adopt daily in arrears  Risk-Free Rates (RFR) as opposed to forward looking term rates. And having settled on daily in arrears rates, the question of how to calculate averages arises - simple averaging or daily compounding. Consensus seems to be building towards daily compounding as it’s a more accurate reflection of the time value of money, though that still leaves questions on how those compound averages should be calculated, the focus of this note.

UK was leading the way...

So far the UK market has led the way with adopting a standard set of conventions for SONIA compounded averages across product sets, with FRNs following swaps, and loans following FRNs.  Early on the UK opted for a 5 day "observation lag" which is a lookback with the day weighting remaining against the Interest Period ("rate shift not weight shift") for both FRNs and loans.

...but the US is catching up

However, the US market has become much more vocal on this topic recently.  The ARRC released conventions papers in August and November,  and the New York Federal Reserve has launched a consultation on publishing SOFR compound averages and an index on their website.

Most recently, an ARRC loans sub-working group is reviewing alternative compounding approaches in order to address requirements of the secondary loan trading market in relation to interest allocation and provide loan platform providers with clear methodologies to code into their systems – expect a recommendation from the working group to the ARRC early in the new year.  

The latest ARRC paper lists three models for SOFR FRNs using the Daily Compounding method:

  1. Lookback - same as the SONIA standard for FRNs and Loans, with [5] day lag of the daily rate to the earlier Observation Period but with day weighting remaining against the Interest Period
  2. Observation Period Shift- 'Backward-shifted' model where both rate and day weighting shifts back to the earlier 'Observation Period'
  3. Payment Delay- in ARRC paper this option includes both a Payment Delay (eg settlement 2 days after Interest End Date) and a Lockout (daily rate 'suspended' for final [2] days of interest period, referred to as 'Rate Cut-off Date'); note in FSB paper these options are presented separately 

The "weight" refers to the weighting in the compounding formula to account for calendar days when the RFR is not published (e.g. at weekends).

Outside of the averaging approach, other details also vary between benchmarks...SONIA and euro short-term rate (€STR) derivatives round to 4 decimal places by default, whereas SOFR rounds to 5 dps.  SOFR and €STR use an Actual/360 day count convention, whereas SONIA uses Actual/365. These are well known defaults within the international swaps markets, but may not be so familiar across the wider industry. See the table below for a comparison of conventions.

Does it matter which compounding method is chosen?

In practical terms many of these alternatives don’t result in material differences in the level of interest payments.  It’s more about the industry picking one answer and being consistent, to make it easier for everyone.

And we’d argue it’s probably more important to achieve consistency within an asset class across jurisdictions than to achieve alignment between asset classes.  For example multi-currency loans would be simpler to implement if they shared common standards across jurisdictions & RFRs.  Whether FRNs match Loans in their approach is perhaps less of an issue.

So who's the winner?

Although SONIA developed its standards earlier (#1), it looks like the US market is leaning towards backward-shift (#2), with the results of the recent International Swaps and Derivatives Association (ISDA) Fallback consultation lending further weight to that model. The Payment Delay / Lockout model (#3) seems to have less support, particularly given it could lock in an unexpected spike in daily rates for an additional period.

Whatever the answer, will continue to support the conventions as they emerge.  Read on below for a brief explanation of the main models with worked examples to show how the rates differ depending upon day weighting.

And our calculator has recently been upgraded to display the most recent SONIA rate from previous business day following publication at 9:00am by Bank of England (BoE) - click through to the SONIA page and register to see the latest rate. As ever, we welcome feedback on the calculator - let us know what you think at

Conventions Table

Below we list the main RFRs and conventions, though it should be noted that there is not yet consensus around the FRN and Loans space, and in many cases there are a number of different defaults already in use in different live transactions.  Although not exhaustive, below gives a feel for the range of options in play. 

  1. rounding decimal places (dps) shown for OIS per ISDA 2006 Definitions, defaults for FRNs and Loans vary, no clear consensus though mainly follow OIS standard
  2. no SARON or TONA FRNs or Loans available, so not clear what Day Weighting convention might be used yet
  3. use "Reset Type" in Calculator Options to toggle between Lookback ("ResetDaysPrior" in drop list) and Backward Shift mode

For a detailed description of many of these terms see the ARRC Appendix to SOFR FRN Conventions Matrix.  See also the original FSB RFR User Guide, the SONIA conventions paper and recent Swiss Average Rate Overnight (SARON) working group material.

Lookback v Backward Shift

The table below shows how Lookback and Backward Shift models result in different compounded rates due to different day weighting in Interest and Observation Periods.
(SOFR compounding, based on $10m national, start 28 May, end 5 June, 5 day lag)

Use our Calculator!

The good news is that our calculator at supports both these modes via the Advanced option "Reset Type".  For Lookback (#1) select "ResetDaysPrior" and for Backward Shift (#2) select "BackwardShift":  

This article has been prepared for information purposes only, does not constitute an analysis of all potentially material issues and is subject to change at any time without prior notice. NatWest Markets does not undertake to update you of such changes.  It is indicative only and is not binding. Other than as indicated, this article has been prepared on the basis of publicly available information believed to be reliable but no representation, warranty, undertaking or assurance of any kind, express or implied, is made as to the adequacy, accuracy, completeness or reasonableness of the information contained in this article, nor does NatWest Markets accept any obligation to any recipient to update or correct any information contained herein. Views expressed herein are not intended to be and should not be viewed as advice or as a personal recommendation. The views expressed herein may not be objective or independent of the interests of the authors or other NatWest Markets trading desks, who may be active participants in the markets, investments or strategies referred to in this article. NatWest Markets will not act and has not acted as your legal, tax, regulatory, accounting or investment adviser; nor does NatWest Markets owe any fiduciary duties to you in connection with this, and/or any related transaction and no reliance may be placed on NatWest Markets for investment advice or recommendations of any sort. You should make your own independent evaluation of the relevance and adequacy of the information contained in this article and any issues that are of concern to you.

This article does not constitute an offer to buy or sell, or a solicitation of an offer to buy or sell any investment, nor does it constitute an offer to provide any products or services that are capable of acceptance to form a contract. NatWest Markets and each of its respective affiliates accepts no liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this material or reliance on the information contained herein. However this shall not restrict, exclude or limit any duty or liability to any person under any applicable laws or regulations of any jurisdiction which may not be lawfully disclaimed.

NatWest Markets Plc. Incorporated and registered in Scotland No. 90312 with limited liability. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and Prudential Regulation Authority. NatWest Markets N.V. is incorporated with limited liability in the Netherlands, authorised and regulated by De Nederlandsche Bank and the Autoriteit Financiële Markten. It has its seat at Amsterdam, the Netherlands, and is registered in the Commercial Register under number 33002587. Registered Office: Claude Debussylaan 94, Amsterdam, the Netherlands. Branch Reg No. in England BR001029. NatWest Markets Plc is, in certain jurisdictions, an authorised agent of NatWest Markets N.V. and NatWest Markets N.V. is, in certain jurisdictions, an authorised agent of NatWest Markets Plc. NatWest Markets Securities Japan Limited [Kanto Financial Bureau (Kin-sho) No. 202] is authorised and regulated by the Japan Financial Services Agency. Securities business in the United States is conducted through NatWest Markets Securities Inc., a FINRA registered broker-dealer (, a SIPC member ( and a wholly owned indirect subsidiary of NatWest Markets Plc.

Copyright 2022 © NatWest Markets Plc. All rights reserved.

scroll to top