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Interest rates 13 Sep 2018

ESTER, the proposed alternative risk-free rate for the Eurozone

The reform of the reference rates in the eurozone to adapt to the new regulations, driven by the European Central Bank (ECB) along with other authorities, is taking shape. Today the ECB has announced a proposal for a new intraday rate as an alternative to the Eonia: the ESTER.

The ECB, along with other European authorities, has driven a reform of Euribor and Eonia to increase its transparency and adapt to European legislation and international organization recommendations.

To this end, in 2018 a working grouped was created, formed by European authorities and financial institutions responsible for identifying and recommending alternative reference rates to Euribor and EONIA, used in a wide range of financial instruments and contracts in the euro area.

The first step has been to work on an alternative to EONIA. “This is because the EONIA as it stands will no longer meet the criteria of the EU Benchmarks Regulation and will therefore see its use restricted as of 1 January 2020”, said the ECB in a press release.

Unlike Euribor – which is generally used as a reference to calculate the interest rate of mortgages, syndicated loans, variable rate debt issuance and derivatives-, Eonia is one of the reference interest rates most widely used in the Eurozone interbank market. It is currently calculated as the weighted average of the overnight borrowing rate of European banks, as reported by a panel of 28 contributor banks.

The alternative rate to Eonia chosen by the working group is ESTER, a new overnight reference rate for the euro interbank market, calculated by the ECB, which the institution will begin to publish daily at the latest as of October 2019.

Who is involved in the reference rate working group?

The working group is an industry-led group. Specifically, it includes 21 credit institutions– as voting members-, five institutions as non-voting members and one institution, the European Investment Bank (EIB) as an invitee. The ECB acts as an observer.

The group of experts is studying potential approaches to ensure a smooth transition for the new rates, minimizing market interruptions and safeguarding the continuity of contracts as much as possible.

Previous experiences in other countries

The working group created in European follows in the wake of others created previously in countries such as Japan, the United Kingdom, the U.S. and Switzerland.

In the case of the U.S., in 2014 the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of New York created the Alternative Reference Rate Committee (ARRC) to identify best practices for alternative reference rates, develop an adoption plan and an implementation plan thereof.

In June 2017, the ARRC identified SOFR (Secured Overnight Financing Rate) as the best rate to replace LIBOR for U.S. dollars. The SOFR began to be published in April 2018, with the aim of reducing dependence of U.S. dollar markets on LIBOR, the most used reference rate to date.

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