In 2013, a global effort to reform benchmarks of interest rates was launched to make these indices less subject to manipulation and to make them more representative of broader market conditions.
In the EU, this global effort was manifested by the EU Reference Rates Regulation – Regulation (EU) 2016/2011 (BMR), which entered into force in June 2016 and became applicable from of January 2018. The BMR regulates indices used as benchmarks in financial instruments and financial contracts, as well as indices measuring the performance of investment funds.
In the euro area, EURIBOR has traditionally been the main benchmark rate in terms of the number of contracts and is widely used in personal loans and hedging products. The EONIA (the Euro Overnight Index Average) is the second most important benchmark and has been the preferred overnight rate of all overnight unsecured loan transactions. EURO LIBOR is also used but on a smaller scale.
The first step in reforming global benchmarks was the development of so-called risk-free rates (RFRs). The table below shows the main RFRs for several global currencies. In the euro area, the overnight Euro Short-Term Rate (€ STR), administered by the European Central Bank (ECB) and officially published for the first time on October 2, 2019, will become the standard RFR.
Transition to € STR: key points
The table below summarizes the key points of the main benchmarks currently used in the euro area. Specifically, it describes how these benchmarks are calculated and whether they will become obsolete.
The € STR should replace EONIA by the end of 2021. In anticipation of this, the calculation method of EONIA has been reformed. Indeed, on the date of the first official publication of the € STR, the European Monetary Markets Institute published a revised EONIA, changing this index from an index based on transaction-based submissions by banks of the panel to a peg to the € STR with a fixed spread of 8.5 basis points. . This spread was calculated by the ECB on May 31, 2019 and reflects the historical difference between the two benchmarks.
During the transition period, no new EONIA listing contracts should be issued to the extent possible. In addition, all old and existing contracts expiring after the transition period should be amended as soon as possible to include an EONIA replacement rate based on € STR and to incorporate robust fallback provisions. Finally, all new EONIA listing contracts should include fallback provisions to enable the transition to € STR after the end of the transition period.
EURIBOR has been satisfactorily reformed to include transaction data as well as expert advice, and can therefore continue to be used for the time being. Despite this, fallback provisions should be incorporated into loan agreements in order to guard against a possible future final shutdown of EURIBOR.
EURO LIBOR is the least used of the LIBOR currencies and its usage is significantly lower than EURIBOR. In July 2017, the UK’s Financial Conduct Authority announced that market participants should not expect LIBOR to remain available after 2021. This discontinuity will inevitably mean that EURO LIBOR will also have to be replaced by l ‘€ STR by the end of 2021.
Transition to € STR in Germany
The EONIA listing contracts will have to be modified in Germany in view of the changeover to € STR. Among other financial contracts, these changes are to be made to the German framework agreements for financial transactions (Deutsche Rahmenverträge für Finanzgeschäfte) and their addenda which can be considered as the equivalent in German law of the ISDA framework agreement.
The most relevant agreements in this context are the framework agreement for financial derivative transactions (Deutscher Rahmenvertrag für Finanztermingeschäfte), the framework agreement for securities lending (Deutscher Rahmenvertrag für Wertpapierdarlehen) and the framework agreement for repo transactions (repos) (Deutscher Rahmenvertrag fürges Wertpapierdarlehen) Repos)).
On June 18, 2020, the German Banking Association (Bankenverband) published a model supplemental agreement for the transition from EONIA to € STR. The model is designed to cover German framework agreements for financial derivative transactions, for securities lending and for repo transactions.
As usual in German framework agreements, the supplemental agreement template is organized in a modular fashion so that the parties can adapt the agreement by selecting the specific options to be applied. In each part of the model, parties can select the items covered, the provisions covered, the agreed replacement benchmarks and the transition method. This template also provides fallback provisions for using € STR as an alternate benchmark.
Regulations and recent announcements at EU level
On December 7, 2020, the European Council of the EU approved the agreement reached to amend Regulations (EU) 2016/1011 and (EU) 648/2012. These changes will allow a statutory benchmark to replace benchmarks in contracts in which there is no fallback clause or to replace a fallback clause deemed inappropriate by regulators, for example, because it could have a negative impact on financial stability.
Finally, on January 19, 2021, the European Commission adopted provisions giving it the power to replace “critical” benchmarks. These critical references are those that influence a large number of financial instruments and contracts (> 500 billion euros). They also include those which have no or few substitutes, or are non-European third-party references whose termination would present a systemic risk for the Union’s financial system. Note that LIBOR will fall into the last category after Brexit.
The transition to RFR is well underway around the world. In the EU, the introduction of the € STR on October 2, 2019 was the first big step. The transition from EONIA to € STR, including the amendment to contracts referencing EONIA, must be fully completed by the end of 2021.
At the same time, to cover all eventualities, fallback provisions based on € STR should be included in new and old EURIBOR benchmark contracts, even though EURIBOR has been sufficiently reformed and will continue.