What exactly is the difference between the fixed rate of an OIS and the risk-free rate in that currency. For example, in the US the OIS rate vs. risk-free rate SOFR or in the UK the OIS rate vs. the Sterling risk-free rate SONIA - don't the rates and the risk-free rate coincide?

In the context of the IBOR cessation / transition to risk-free rates, I've heard to SONIA discussed, but also fallback to a OIS rate. What is the difference?

I thought a RFR was determined by such the fixed rates of OIS transactions. I'd appreciate any help! Kind regards.

  • 1
    $\begingroup$ RFR is probably a misnomer, there is nothing risk free about it! But then compared to LIBOR, is far less risky! The original intention of the IBOR transition was to establish robust benchmarks (focus on plural!)- ideally a risk free benchmark plus a few more to capture the various markets, but it was soon realised that multiple benchmarks might not be possible due to liquidity. OIS literally means any swap on an overnight index- as the new RFRs are o/n rates, so swaps on these could be called OIS. E.g., swap on the USD SOFR and Fed rate both would be OIS, but name will refer to the primary one $\endgroup$ Oct 23 '20 at 7:29

RFR (risk free rate) is the current acronym ISDA, central banks and regulators are pursuing to signify and politicise the transition from IBOR, which has been dogged by rigging scandals.

OIS (overnight index swap) is the acronym that has been associated with an unsecured overnight interbank cash lending rate fixing (OIS fixing) (with different calculation rules in different currencies), as well as in regard to the derivatives (swaps) that settled against compounded or averaged OIS fixings.

Some identified RFRs eg SOFR are now targeting collateralised repo transactions as their underlying data source in calculation. Since clearing houses use these rates for the collateral remuneration of the derivatives it makes sense to adopt a collateralised rate rather than an uncollateralised lending rate.

SONIA, and ESTR are outlined as the candidates for RFR in sterling and Euro even though it is still based on uncollateralised lending. I suspect these decisions are based on data availability in each currency as well as established processes that may already be fit for purpose.

After the cessation of IBOR, i.e. IBOR is no longer calculated and published in the old way, the designated RFRs in each currency will be used to derive IBOR rates for the purpose of settling legacy derivative contracts. In fact, RFRs, which represent overnight rates will be compounded over the relevant IBOR tenor and have a 'spread adjustment' applied to reflect the missing 'term credit risk' component. Bloomberg has been designated as the calculation agent and they have published documents about their processes on their website.

  • $\begingroup$ Just for terminology (maybe even as a future reference?), I would add the distinction between OIS (a traded derivative) and an underlying risk free rate. I would argue that the RFR (SOFR, ESTR, SONIA) are - per se - interest rate indices with varying fixing mechanisms. Now as these are declared as price alignment interest rates (PAI) in CSAs or clearing regulations, financial theory stipulates that the corresponding underlying OIS market shall be used to find risk free curves for valuation purposes, i.e. OIS curves. Would you agree? $\endgroup$ Oct 23 '20 at 6:59
  • $\begingroup$ @Kermittfrog yes that is correct. The OIS fixing, e.g SONIA fixing and EONIA fixing, being a key determinant in the pricing of overnight index swaps (OIS) has always been a bit of a nomenclature issue in the sense 'OIS' was used for both meanings sometimes. $\endgroup$
    – Attack68
    Oct 23 '20 at 8:33

Isn't the "Risk-Free-Rate" (RFR) just a rebranding of LIBOR/EURIBOR, as was? IE these are not "risk-free" so much as interbank, ie the "liquid benchmark for very-short-term very-low-risk".

Unless you work in the fixed-income department of an investment bank, the distinction is probably superfluous; so genuinely not worth worrying about. In simplest layman's terms, an OIS swap is us betting about overnight rates. I'm not lending or borrowing a billion; but we pay or receive a billion's worth of the difference to our agreed swap rate. If you go bust, I lose only this difference (maybe a few million). At LIBOR/RFR, I have lent or borrowed the billion from/to you, so the risk is the billion itself. Simplifying massively, this is the key difference.

  • $\begingroup$ This is not true. RFRs are closer to OIS fixings than to LIBOR (in GBP and EUR the RFR is effectively OIS fixing, in GBP it is even called the same - SONIA). In USD the RFR is based on collateralised repo transactions, rather than uncollateralised overnight lending. IBOR is unsecured term lending and is therefore different to RFRs, however the RFR will be used in the reproduction of IBOR rates with various compounding and adjustment factors once IBOR disappears for legacy trades. $\endgroup$
    – Attack68
    Oct 24 '20 at 11:14
  • $\begingroup$ Thanks, I stand corrected. But then how does the trillions of structured product biz etc. price off RFR/OIS if these have to be collateralised; or the banks trading anything else have a different financing rate to RFR? What am I missing here? $\endgroup$
    – demully
    Oct 24 '20 at 18:42
  • $\begingroup$ A bank derivative (vanilla or structured) will have a forecast curve for settlement and a discount curve for valuing the forecast cashflows. An RFR, OIS, or IBOR is just a published interest rate that can be used for either of the previous. It just happens that currently the majority of derivatives use IBOR for forecasting and OIS for discounting, although recently this has transitioned to RFR for discounting (which in some currencies is the same as OIS) and when IBOR stops being published it will have a fallback calculation based on RFR rates. $\endgroup$
    – Attack68
    Oct 24 '20 at 21:16

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