EONIA unlikely to meet the requirements of the European Benchmark Regulation
EMMI has announced that it will no longer pursue a thorough review of EONIA. Citing data analysed in the second phase of its EONIA Review and in the ECB’s recent public consultation, EMMI has concluded that there is “a fair degree” of concentration in the interbank lending activity captured by EONIA, potentially increasing the influence of single contributors to the benchmark, as well as geographical concentration. EMMI also found that the inclusion of currently ineligible financial instruments would not significantly improve the representativeness of the benchmark.
Instead, EMMI suggests that redefining EONIA as an overnight wholesale borrowing benchmark would be most likely to address these issues, giving rise to a more robust and representative rate with a lower geographical concentration. It notes that this would require a shift to the borrowing side to capture higher volumes and a broader range of counterparties.
In its statement, EMMI concludes that, while the definition and calculation methodology of the rate remain in their current format and in the absence of changes to market conditions and dynamics, EONIA’s compliance with the European Benchmark Regulation (EBR) by January 2020 “cannot be warranted”.
EMMI goes on to confirm that daily publication of the rate, which was designated a critical benchmark under the EBR on 28 June 2017, will continue “as-is”. In addition, as a critical benchmark, a College of Supervisors has been established with authority to ensure the stability of the EONIA panel and continuity of the provision of the benchmark in accordance with the provisions of the EBR. EMMI will also review its methodology on an annual basis and may consider adapting methodological parameters to enhance robustness if necessary.
The statement provides some comfort to the market, noting that, under the transitional provisions of the EBR, EONIA may continue to be used as a reference rate until 31 December 2019. Following that date, EONIA could only be used in existing contracts as permitted by the Belgian supervisor, the FSMA, where cessation or changes to the benchmark to comply with the EBR “would result in a force majeure event, frustrate or otherwise breach the terms of any financial contract or financial instrument or the rules of any investment fund” referencing the benchmark as set out in Article 51(4) of the EBR.
Even if the continued use of EONIA in existing contracts is grandfathered beyond 31 December 2019, a new overnight rate will be required for contracts entered into from that date. In addition, market participants will need to assess the range of contracts that refer to EONIA and consider whether, notwithstanding any grandfathering, those references should be updated. For example, EONIA is commonly referenced as the interest rate, and in the case of cleared transactions the rate for price alignment interest (PAI), for euro-denominated cash collateral. A protocol could assist the derivatives market in moving to a new rate but the first priority must be the determination of a suitable euro risk-free rate and its establishment, if necessary, as well as the development of transition plans for the adoption of that rate.
The Euro Working Group on Risk-Free Reference Rates (the Euro RFR WG) is currently working to identify a suitable rate. It is now clear, however, that this will not be EONIA, at least not in its current form. Given the requirements of the EBR and EMMI’s interpretation of these in the context of EONIA, the Euro RFR WG now faces challenging timing constraints if market disruption is to be avoided post 31 December 2019.
In addition, EMMI’s statement on EONIA highlights benchmark users’ responsibilities to consider whether selected benchmarks meet their, and their clients’, needs on an ongoing basis under the EBR and the IOSCO “Statement on Matters to Consider in the Use of Financial Benchmarks” of 5 January 2018. The suggestion clearly being that, notwithstanding the transitional provisions of the EBR, users should consider the suitability of EONIA going forward. EMMI also emphasises the need for thorough consideration of contingency plans for benchmark cessation and, in particular, the inclusion of fallback provisions in contractual arrangements.
The recent IOSCO statement, whilst taking the form of guidance, encourages all benchmark users to consider the appropriateness of benchmarks and the need for robust policies to address benchmark cessation, including contractual fallback provisions. These obligations may go beyond those required under the EBR or equivalent legislation.
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(1). EMMI has separately announced that it will participate in the Euro RFR WG as an administrator of critical benchmarks and on a non-voting basis in order to provide input on the development of robust and reliable reference rates.