IBOR-Reform / News
13. September 2018
ECB working group recommends ESTER as euro risk-free rate and replacement for Eonia
The ECB Working Group on euro risk-free rates has selected the successor index to the Eonia (see press release). The favourite euro short term rate (ESTER) received the required two-thirds majority. As Eonia does not conform to IOSCO/EU BMR, new business may no longer be concluded on the index from 1 January 2020. ESTER will be an alternative reference value.
Eonia and ESTER represent the average interest rate for unsecured overnight borrowing. While Eonia only includes interbank transactions, ESTER widens the scope to include wholesale borrowing transactions to banks. For the calculation of the Eonia, 28 panel banks voluntarily submit the qualified transactions on a daily basis. Eonia is the weighted average of these contributions. ESTER, on the other hand, is based on daily submissions by banks, which are obliged under the MMSR Regulation to report transactions for the calculation of ECB statistics.
When Eonia was introduced in 1999 as the first transaction-based interest rate index, it was considered innovative and forward-looking. In February 2018, EMMI announced that the reform of the Eonia had failed and that no further efforts would be made to reform the index in line with the IOSCO/EU BMR. The volume of the interbank market has fallen so severely that individual transactions can have a significant impact on Eonia. Thus, the discontinuation of Eonia also highlights the problems in EURIBOR / LIBOR: due to a lack of liquidity, an alternative for these benchmarks is also inevitable.
Since Eonia is not IOSCO/EU BMR-compliant, no new business may be concluded on the index from 1 January 2020 according to the EU Benchmark Regulation. As a result, the working group identified three possible successor indices. In addition to ESTER, GC Pooling or RepoFunds Rate could also have replaced Eonia. In the course of the subsequent public consultation, the majority of the institutions surveyed opted for ESTER as a suitable overnight rate. Today’s election takes account of this vote, which was published in early August 2018.
According to the ECB, ESTER will be published in October 2019 at the latest. A transition period of only three months will present most institutions with a major challenge. It is expected that the ECB will make every effort to publish ESTER before October 2019. In this context, the ECB will shortly announce whether an earlier publication of the index is possible.
Until the official launch of the ESTER, the ECB will publish the transitional interest rate Pre-ESTER. It is intended to facilitate the introduction of ESTER for market participants and to support the development of time series. Both interest rates are calculated using the same methodology. In contrast to the final ESTER, the Pre-ESTER contains all cancellations, revisions and changes of transactions up to the time of calculation, in addition to the transactions executed until 07:00 CET on the following day. The final ESTER will be corrected for these additional data errors. ESTER will be released at 9:00 CET on TARGET2 business days in the future.
For further information please read: https://www.l-p-a.com/risk-quant-consulting/ibor-reform/
Christian Behm, CFA, is with LPA since 2004. He has broad experience in advising banks and has got a distinct capital markets focus. As Partner he is responsible for LPA’s Risk & Quant Consulting Practice and he covers large consulting mandates.