The future is EURIBOR

“THE FUTURE IS EURIBOR”

EXCLUSIVE. The European Money Markets Institute (EMMI) is going to propose a “fallback rate” in the fourth quarter of 2022. Satu Huber explains why to Revue Banque. Ensuring the long-term survival of EURIBOR, putting in place this new service and providing additional support to the money markets, and benchmarks constitute the three priorities of the new chair of the association that administers the benchmark for interbank loans in the euro zone (see page 83).

After seven years on the Strategic Committee of the Agence France Trésor (French Treasury) and twelve at the head of a Finnish pension fund, you’ve joined the EMMI. What are the priorities for your presidency?

The basic priority for the EMMI, as administrator of the EURIBOR, is to ensure its long-term survival. To do that, we watch to make sure the benchmark is always representative of the underlying market. Currently it is, since it is estimated that depending on maturities, EURIBOR captures around 60% of the market by volume, with 18 banks from nine countries. However we are aiming to further diversify the panel of everyday contributors to EURIBOR in terms of geography and types of institutions. It’s a long process of discussion with users. We hope to attract some new major European banks, particularly from the Nordic countries. But we’re not targeting any particular countries, since everyone uses EURIBOR.

We’re also moving towards simplifying the everyday process, which is fairly onerous for the banks, by exploring with them the means whereby the EMMI, as administrator, could centralise the level three contributions. Level three contributions are based on transactions, using a combination of modelling techniques and the panel bank’s judgement. With respect to level one contributions, which are based on banks’ eligible transactions in the interbank market, and level two contributions, which use a defined range of techniques for calculating formulas, level three contributions are the most used in the EURIBOR calculation methodology but also the most onerous. They represented 60% of short-term maturities and as much as 70% of the longest maturities up to March and have represented 45% and 60% respectively since then. These figures are currently falling as a result of the rise in interbank markets and the increase in volumes and number of transactions.

Then there were the regulators who demanded that all contracts using benchmarks such as EURIBOR provide a fallback rate as a precaution, which the parties would use if the benchmark were to change materially or cease to be provided. One of the EMMI’s priorities is to develop its own fallback rate, the EFTERM (euro forward term rate) which we aim to make available starting in the fourth quarter of 2022. We’re currently in the test phase with the publication, every week since June, of beta rates and we have a public consultation on the functionalities which ends on August.

A “fallback rate”… is EURIBOR going to disappear?

The future is EURIBOR. There's never been a single signal, on our part as administrators or on the part of any public authority or supervisor indicating that it was going to disappear. Everyone, including Steven Maijoor, the former president of ESMA, the European Securities and Markets Authority, has said that EURIBOR complies with the Benchmark Regulation (BMR), that there are no plans to discontinue or replace it and that it is not LIBOR. And then the reform of EURIBOR, adopting the hybrid methodology in 2019, was a great success. Since then, everything has worked well and EURIBOR has always been representative of the underlying market, even in adverse market scenarios such as that associated with Covid, and now with the geopolitical events, inflation and movements in interest rates. Two annual reviews of the methodology have already been concluded, showing that it is well-suited to the objective. And for adjustments to the methodology, we always rely on feedback from the market and from ESMA. As regards the fallback rate, as mentioned previously, it isn’t there to replace EURIBOR but is imposed by the Regulation. As administrators, we have therefore taken the initiative of strengthening EURIBOR and ourselves proposing to all users this service which follow the recommendations of the Risk-Free Rates Working Group (RFRWG) and the global view of the markets. The fallback rates will be distributed with the EURIBOR rates, without additional cost: for a single user (such as an SME), currently at around €530 per screen per year. Another organisation has proposed a similar solution to ours. Users can choose.

Apart from administering EURIBOR, what’s your role with the market?

Providing additional support for the market’s demands in the field of money markets or benchmarks is also an aspect of one of our priorities. It involves providing more support to initiatives that facilitate the integration of the European money markets – such as the STEP (Short-Term European Paper) initiative that we have been successfully promoting for 15 years now – and reacting to the additional requests from the industry in terms of benchmarks. Certain markets are showing interest in or looking for a benchmark administrator. We’re there to listen and consider what else can be done in addition to what has already been done. We engage in discussions with some of them and have put forward certain possibilities, but there aren’t any specific projects in the pipeline at the moment. We play the role of facilitator with the technology, systems and skills needed to accompany certain market initiatives.

“A benchmark for the interbank market must reflect all the expectations of the market, including increases in inflation and actual and expected increases in interest rates. Since the beginning of the year, EURIBOR has reflected all of these very well.”

How did the transition from EONIA to €STR go?

The transition from EONIA to €STR took place in January 2022 without any interruption. Discontinuation of EONIA had been programmed since 2019 by the EMMI, and all the users were fully prepared. It was a very good example of how market forces, in this case the RFRWG, which reflects all the interests in the market and the public sector, can work together to implement a smooth transition solution.The transition was based on a change of methodology whereby, instead of calculating EONIA on the basis of contributions from a panel of banks, we moved to a tracker of euro short-term rates with a fixed spread of 8.5 basis points. Warning the market in advance by publishing a discontinuation date was also a key factor in this overall success.

How is the central bank’s monetary policy passed on to the interbank rates?

In principle, a central bank’s key rate, plus the expectations that they create, will form the interbank interest rate curve. When a central bank clearly indicates that it is going to tighten the monetary taps, it is understood that it will increase its rates sooner or later. In reaction to this, interbank rakes adjust and the curve steepens. An index that is representative of the money market will reflect what happens at the monetary level. A term curve is not flat and does not reflect only the central bank’s key rates, which are overnight rates and do not go any further. Therefore a benchmark for the interbank market, such as EURIBOR, must reflect all the expectations of the market, including increases in inflation and actual and expected increases in interest rates. Since the beginning of the year, EURIBOR has reflected all of these very well.

In this context of changing expectations on interest rates, we see in the volumes of EURIBOR and those published in the ECB’s statistics a recovery in interbank transactions and in banks’ transactions with their end customers. This explains the current increase in level one contributions to the detriment of level three contributions. When we were in a period of low interest rates, unchanged rate expectations and surplus liquidity in the market, the volumes were low but sufficient.

Reporting by Sylvie Guyony and Tân Le Quang.

 Link to the French version on Revue Banque website : « Le futur, c’est l’EURIBOR » (revue-banque.fr)