The reform of the reference rates in the euro area to adapt to new regulations, promoted by the European Central Bank (ECB) along with other authorities, is taking shape. On October 2, the ECB began publishing a new overnight rate: the €STR.
The ECB, along with other European authorities, has driven a reform of Euribor and Eonia to increase their transparency and adapt to European standards and recommendations from international organizations.
To this end, in early 2018 a working group formed by European authorities and financial institutions was created, to identify and recommend alternative reference rates to Euribor and Eonia, used in a wide range of financial instruments and contracts in the euro area.
The Eonia is one of the most used interest rates in the Euro area’s interbank market. Until October 1, 2019, it was calculated as the average of all overnight unsecured lending transactions, as reported by a panel of 28 contributor banks to the European Monetary Market Institute (EMMI).
From now on, the Eonia will be calculated at a 8.5 basis points positive spread on the basis of a new rate: the Euro short-term rate (€STR). This new benchmark is calculated as the weighted average of the individual transactions in the European monetary market reported by 50 credit institutions every day to the ECB. The rate weighs in not only interbank transactions, but also the interest rate paid by banks on deposits from other counterparties, such as investment and pension funds.
The €STR, a new reality
The €STR was published for the first time on Wednesday, October 2, with a fixing set at -0.549 percent, with reference date October 1, 2019. The ECB’s calculation was based on 32 active banks and 432 actual transactions. The resulting Eonia was -0.464 percent (-0.549 percent plus the aforementioned +0.085 percent spread) with reference date October 1, 2019, in continuity with the September 2019 fixing (-0.451 percent).
That same day, BBVA completed its first €STR-referenced transaction, a €500 million 1-month call money swap.
Eonia and €STR will continue to coexist through December 2021. On that date Eonia will be discontinued. Over this period of time, the market will gradually replace Eonia with €STR in all products and contracts. After that, the €STR will become the new overnight lending reference rate.
Prior experiences in other countries
The working group created in the Euro area 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 benchmark rate to date.