What Is a Benchmark Rate?

Bank sales staff, traders and settlement staff who handle floating-rate loans and interest rate swaps check the interest amount from the benchmark rate and the period stated in the contract.

Benchmark rates set the amount of interest

The amount of floating-rate interest depends on the value of the benchmark rate referenced¹.

Consider a hypothetical example in which a trade has a notional amount of 5 billion yen and floating-rate interest is paid every three months. Suppose it references a three-month term rate, and the rate published at the start of a period is 0.40% a year. The interest for that period is then fixed at the start of the period: 5 billion yen × 0.40% × 0.25, or 5 million yen². If the published rate is 0.50% a year, the interest is 6.25 million yen. If the same trade instead references a rate that compounds the daily overnight rates over the period, the amount becomes known only on the last day of the period¹. The next section explains the difference between these two approaches.

Figure description

Read the figure in time order. First, the two companies agree in the contract on the benchmark rate and period to reference (dashed; the arrow direction has no meaning). Next, the administrator publishes the three-month value at the start of the interest period (dashed; Company F refers to the same value). Finally, Company F pays interest to Bank E (solid). The benchmark rate value is information that passes from the administrator to the parties to the trade, and money moves only from Company F to Bank E.

The parties to a trade agree in the contract on the benchmark rate and the tenor they reference, and they use the published value for each interest period. JBA TIBOR Administration describes TIBOR (Tokyo Interbank Offered Rate) as one of the yen benchmark rates used in many kinds of transactions, including loans and derivatives³.

An administrator calculates and publishes the value of a benchmark rate by a set method. For interbank benchmark rates (IBORs) such as TIBOR, several banks each submit rates to the administrator, and the administrator combines them to set the value. For TIBOR, the banks that submit rates (panel banks) are called reference banks³. The yen rate TONA (Tokyo Overnight Average Rate), by contrast, is calculated and published by the Bank of Japan from actual transactions⁴⁵.

Overnight rates and term rates

An overnight rate is the rate on borrowing and lending in which the funds are repaid on the business day after they are delivered. In the Bank of Japan's call market statistics, the rates on transactions that are agreed and settled on the same day and repaid on the next business day are overnight (O/N) rates, and the rates on transactions for two business days or longer are term rates⁶. TONA is the rate on those overnight transactions in which financial institutions borrow and lend without collateral⁷.

A term rate is a rate for a period longer than one day, such as one week or three months. Japanese Yen TIBOR and TORF (Tokyo Term Risk Free Rate) are term rates published for each tenor, such as one month and three months³⁸. As with the 5 million yen in the first section's example, when a trade references a three-month rate, the three-month value fixed at the start of the period sets all the interest for that period¹. This approach, in which the rate is set at the start of the period, is called fixing in advance.

In a trade that references an overnight rate, the interest for a period is not known until the end of the period. An OIS exchanges a fixed rate for a floating rate calculated by compounding the daily overnight rates over a set period. The floating payment amount is fixed on the last day of the period¹. This approach, in which the rate is set at the end of the period, is called fixing in arrears. Among yen benchmark rates, TIBOR and TORF are rates fixed in advance, and TONA is a rate used with compounding in arrears⁹. The compounding calculation is covered in Compounding in Arrears.

Unsecured and secured rates

Benchmark rates also differ in whether the underlying borrowing and lending is collateralized. The yen rate TONA⁷, the sterling rate SONIA (Sterling Overnight Index Average)¹⁰ and the euro rate €STR (euro short-term rate) are calculated from rates on borrowing and lending without collateral (unsecured). SONIA covers overnight unsecured sterling deposit transactions¹¹, and €STR reflects the cost to euro area banks of borrowing overnight euros without collateral¹². The US dollar rate SOFR (Secured Overnight Financing Rate), on the other hand, is calculated from rates on overnight repo transactions (borrowing and lending of funds against bonds as collateral) collateralized by US Treasury securities. It is calculated by the Federal Reserve Bank of New York (New York Fed)¹³.

An unsecured rate includes the credit risk of the borrower. When Japan was choosing its yen benchmark rate, one of the issues considered was whether trading practice would run into problems if other currencies chose secured benchmark rates while the yen had an unsecured one. The 2016 report of the Study Group on Risk-Free Reference Rates found that the credit risk in TONA (which the report calls the uncollateralized overnight call rate) is limited, and that the difference from secured benchmark rates is slight. The report concluded that, while it is desirable for each currency's benchmark rate to be on the same side in terms of collateral, this is not essential for trading practice¹⁴.

The idea behind risk-free rates (RFRs)

A risk-free rate (RFR) is a benchmark rate that contains almost no bank credit risk. In a 2014 report, the Financial Stability Board (FSB) recommended basing major benchmark rates such as IBORs on actual transaction data as far as possible, and developing RFRs⁴.

IBORs and RFRs differ in nature. An IBOR is a term rate at which a bank lends to other banks without collateral, so it includes bank credit risk. In many derivatives trades, however, the risks the parties want to take on do not call for a rate that also includes bank credit risk. For this reason, the yen OIS paper says that RFRs and OIS rates are suited to derivatives trades¹. The FSB report also expected RFRs to be used mainly in derivatives trades⁴.

In Japan, the Study Group on Risk-Free Reference Rates identified the uncollateralized overnight call rate, calculated and published by the Bank of Japan, as the yen RFR in December 2016⁵. This rate is TONA. Because an RFR is an overnight rate, it cannot be used as it is when the parties want the rate for a period such as three months to be set at the start of that period¹⁵. For this reason, TORF, a term RFR, is calculated in Japan from the traded rates of yen OISs that are based on TONA⁸.

Later, in July 2017, the Chief Executive of the UK Financial Conduct Authority (FCA) announced that the FCA would not use its powers to sustain LIBOR (London Interbank Offered Rate) after the end of 2021¹⁶. The end of LIBOR publication and the transition away from it are covered in The Transition from LIBOR.

Comparing the major benchmark rates

The table below lists the major benchmark rates. The three yen rates (TONA, TORF and Japanese Yen TIBOR) are the ones the Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks selected as candidates to replace yen LIBOR in its 2019 public consultation⁹. Euroyen TIBOR permanently ceased publication for all tenors in December 2024¹⁷, so the table shows only Japanese Yen TIBOR.

TORF and TONA contain almost no bank credit risk, while TIBOR does⁹. A distinctive feature of TORF is that it uses traded rates from the yen OIS market rather than rates submitted by panel banks, and it uses quoted rates when no trades take place⁸.

Notes

1. Study Group on Risk-Free Reference Rates, "日本円ＯＩＳ（Overnight Index Swap）─取引の概要と活用事例─" (Yen OIS: overview of transactions and examples of use, April 2018, in Japanese), pages 7–8, "①IBOR の性質" (Nature of IBOR) and "②OIS レートの性質" (Nature of OIS rates) under "（１）IBOR とOIS レートの性質の違い" (1. Differences in nature between IBOR and OIS rates). ↩ ↩² ↩³ ↩⁴ ↩⁵

2. To keep the calculation simple, three months is treated as 0.25 years. In actual trades, the length of the period is measured by dividing the actual number of days by 365 or a similar number (Study Group on Risk-Free Reference Rates, "日本円ＯＩＳ（Overnight Index Swap）─取引の概要と活用事例─" (Yen OIS: overview of transactions and examples of use, April 2018, in Japanese), page 5, "変動金利の計算方法" (How the floating rate is calculated)). ↩

3. JBA TIBOR Administration, "金利指標改革を踏まえた全銀協TIBORの現状および今後の展望（2024年６月）詳細説明資料" (Detailed explanatory material on the current status and outlook of JBA TIBOR in light of interest rate benchmark reform, June 2024, in Japanese), page 1 (the second page of the PDF), "①全銀協TIBORとは" (What is JBA TIBOR), "（ご参考）IBOR（アイボー）とは？" (Reference: What is IBOR?) and "〇リファレンス・バンクとは？" (What are reference banks?). ↩ ↩² ↩³

4. Study Group on Risk-Free Reference Rates, "日本円ＯＩＳ（Overnight Index Swap）─取引の概要と活用事例─" (Yen OIS: overview of transactions and examples of use, April 2018, in Japanese), page 1, "１．はじめに" (1. Introduction) and "（わが国における取組みの内容）" (Initiatives in Japan). ↩ ↩² ↩³

5. Study Group on Risk-Free Reference Rates, "日本円のリスク・フリー・レートの特定に関する報告書" (Report on the Identification of a Japanese Yen Risk-Free Rate, December 2016, in Japanese), page 1, "Ⅰ．概要" (Overview). An English version is available: "Report on the Identification of a Japanese Yen Risk-Free Rate", "1. Summary", page 1. ↩ ↩²

6. Bank of Japan Financial Markets Department, "「コール市場関連統計」の解説" (Explanation of call market statistics, in Japanese), page 1, the table in (1) of "１．公表内容" (1. Published data). ↩

7. Tokyo Financial Exchange, "TONA3ヵ月金利先物｜法人のお客様へのご案内" (Three-month TONA futures: information for corporate clients, in Japanese), "TONAとは" (What is TONA). ↩ ↩²

8. QUICK Benchmarks, "TORF概要書" (TORF Methodology, in Japanese; established April 21, 2021, revised October 13, 2021), page 4, "1.1 概要" (Overview) and "1.3 TORFの説明" (Description of TORF). An English version is available: "TORF Methodology". ↩ ↩² ↩³

9. Bank of Japan Financial Markets Department and Financial System and Bank Examination Department, and Financial Services Agency Strategy Development and Management Bureau and Supervision Bureau, "円LIBOR移行対応の振り返りと今後の取り組み" (Bank of Japan Review 2022-J-8, May 2022, in Japanese), page 3, the main text and Chart 2 "代替金利指標の３つの選択肢" (Three options for alternative benchmarks). An English version is available: "Review of JPY LIBOR Transition and Future Initiatives" (Bank of Japan Review 2022-E-4, May 2022), page 3, the main text and Chart 2. ↩ ↩² ↩³

10. Study Group on Risk-Free Reference Rates, "日本円のリスク・フリー・レートの特定に関する報告書" (Report on the Identification of a Japanese Yen Risk-Free Rate, December 2016, in Japanese), page 6, the description of the United Kingdom in "（参考１）他の主要通貨圏におけるリスク・フリー・レートの候補" (Reference 1: Candidates for risk-free rates in other major currencies), which gives SONIA's full name. In the English version, this is on page 7. ↩

11. Bank of England, "SONIA key features and policies," "(ii) Statement of methodology" (the conditions for eligible transactions). ↩

12. European Central Bank, "Overview of the euro short-term rate (€STR)," the opening description. ↩

13. Federal Reserve Bank of New York, "Additional Information about Reference Rates Administered by the New York Fed," "Primary Data Inputs" (the description of SOFR; the start of the heading) and "Data Contingencies" (the entity that calculates the rates). ↩

14. Study Group on Risk-Free Reference Rates, "日本円のリスク・フリー・レートの特定に関する報告書" (Report on the Identification of a Japanese Yen Risk-Free Rate, December 2016, in Japanese), page 4, "② 他通貨圏におけるリスク・フリー・レートとの関係性" (Relationship with risk-free rates in other currencies). In the English version, this is "(2) The relationship of a JPY risk-free rate with risk-free rates in other currencies," pages 4–5. ↩

15. Study Group on Risk-Free Reference Rates, "日本円ＯＩＳ（Overnight Index Swap）─取引の概要と活用事例─" (Yen OIS: overview of transactions and examples of use, April 2018, in Japanese), pages 1–2, "（わが国における取組みの内容）" (Initiatives in Japan), which says a term structure is needed for the rate to serve as a reference rate in place of term rates. ↩

16. Study Group on Risk-Free Reference Rates, "日本円ＯＩＳ（Overnight Index Swap）─取引の概要と活用事例─" (Yen OIS: overview of transactions and examples of use, April 2018, in Japanese), page 2, "（金利指標の存続に関する不透明感の高まり）" (Growing uncertainty over the continuation of interest rate benchmarks). ↩

17. JBA TIBOR Administration, "全銀協TIBOR改革" (JBA TIBOR reform, in Japanese), the description of "全銀協TIBOR改革Next" (JBA TIBOR Reform Next). ↩