EU working group proposes €STR fallback arrangements
13 November 2019 Brussels
Image: Shutterstock The European Central Bank’s (ECB) working group on euro risk-free rates has published a report on recommended fallback arrangements for the new euro short-term rate (€STR).
€STR is the euro risk-free rate set to replace the Euro OverNight Index Average (EONIA), which was previously the preferred overnight rate of all overnight unsecured lending transactions.
The rate switch comes as part of the introduction of the EU’s Benchmarks Regulation (BMR), which first came into effect in 2016. As part of BMR’s introduction, EONIA was reviewed and found to suffer from a lack of underlying transactions and a high concentration of volumes on just a few contributors supporting the benchmark.
Following the EONIA review, the ECB’s private sector working group recommended €STR as a replacement in a 2018 report.
In switching to €STR, BMR requires supervised entities to have “robust written plans” setting out the actions they would take in the event that a benchmark materially changes or ceases to be provided.
The plans should include the nomination of one or more alternative benchmarks that could be referenced to substitute the benchmarks no longer provided.
Today’s report by the working group, which is the latest step in its EONIA to €STR legal action plan, now addresses this specific requirement with two suggestions for fallback arrangements.
The first option suggests switching to one of the two other alternative rates that were considered in the consultation before the selection of the euro risk-free rate.
This includes the GC Pooling Deferred rate, a one-day secured, centrally cleared, general collateral repo rate produced by STOXX; or the RepoFunds Rate, a one-day secured, centrally cleared, combined general and specific collateral repo rate produced by NEX Data Services.
The report noted that the key advantages of these rates are the transactions-only non-panel-based methodologies of both rates, combined with high volumes.
The report goes on to note that both rates reflect the secured market, while the €STR reflects
the unsecured market.
“In times of market stress, market participants may change their funding strategy from unsecured to secured funding, which would make secured rates such as GC pooling deferred or RepoFunds rate a natural alternative" to €STR if it were to permanently cease to exist due to a lack of underlying transactions.
Meanwhile, option two is to take into account the regular review of the methodology of the €STR by the ECB to “provide for the possible cessation of the €STR, combined with the use of fallbacks consistent with the relevant parts of the EONIA fallback”.
The ECB is expected to adopt clear written policies and procedures on actions to be taken in the event of the possible cessation of the €STR in accordance with Article 10 on “cessation of the euro short-term rate” of the guideline on the euro short-term rate.
According to the group’s report, these actions by the ECB are expected to ensure the prolonged existence €STR and will minimise the likelihood of a possible cessation of the €STR.
The periodic review requirements and actions to be taken in the event of a possible cessation of the €STR are in line with the key features and policies of the sterling risk-free rate, Sterling Overnight Index Average, and the data and calculation methodology of the US dollar risk-free rate, Secured Overnight Financing Rate.
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