It’s not just our LIBORs, it’s EURIBOR...

Could that be the sentiment between the UK & US and the EU on benchmark reform?

Is it tenable long term that one global benchmark remains at least partially rooted in submitting banks’ judgement rather than purely observable transactions? With UK and US regulators having placed such emphasis on the importance of the move away from LIBOR and towards Risk Free Rates (RFRs), will the EU remain comfortable with the hybrid waterfall approach of its own IBOR[3] indefinitely?

The Hybrid Methodology used by the European Money Markets Institute (EMMI) since 2019 to construct EURIBOR is Benchmark Regulation (BMR) compliant, and the administrator EMMI makes a strong case that the benchmark remains “robust, resilient, and representative of its underlying market”. In an interview in September last year the recently appointed Chair for EMMI strongly defended the benchmark, with the unambivalent comment « Le futur, c’est l’EURIBOR ». Of course the administrator of EURIBOR does have some skin in the game here.

So how much of EURIBOR is transaction based? There are transparency reports published monthly, with the one from January 2023 showing that around 50% of the submissions use the Level 3 contribution which uses “a combination of modelling techniques and/or the Panel Bank’s judgement” (graph 1 below), with the rest based on L1 & L2 transaction-based submissions. A year earlier in January 2022 L3 made up around 70% of submissions when there was less interbank activity to drive L1 & L2.

That said, it is worth reminding ourselves of what the ECB[4] said back in July 2020 on benchmark reform:

...the long-term sustainability of EURIBOR depends on factors such as the continued willingness of the panel of contributing banks to support it, and whether or not there is sufficient activity in its underlying market. Banks therefore need to be prepared for all scenarios, including the possible disappearance of this benchmark.

In the FSB[5] report into progress of LIBOR transition globally in December 2022, the section on the European Union reflects on the hybrid methodology, the replacement of EONIA[6] with €STR[7] and the progress on adoption of EURIBOR fallbacks, but stops short of any speculation on further plans for EURIBOR. 

So what are some of the factors that might act as catalysts for further reform of EURIBOR?

  • USD LIBOR cessation – as outlined above, once USD LIBOR is gone, will there be greater scrutiny of EURIBOR?
  • EURIBOR panel banks drop out – currently there are 19 panel banks for EURIBOR, some of whom submit today for USD LIBOR as well. Will any start to consider whether to step back from the EUR submitting panel post USD cessation? If that does happen it becomes a self-fulfilling prophecy as the rate becomes less representative with each bank that drops out. That said there is a 12 month notice period, extendable by the ECB to 24 months, when a panel back wants to drop out, so such things don’t happen overnight.
  • Liquidity shift away from EURIBOR – as can be seen from the ISDA[8] report to the EU RFR WG in December, between September 2021 and September 2022 the share of EURIBOR in the EUR swaps markets has dropped from 78% to 55% (see graph 2 below). However this move to €STR is almost entirely in maturities of 3m and under, and there is no meaningful shift away from EURIBOR on longer-dated swaps (and not much move at all in bond & loan markets towards €STR). It is worth noting that with EURIBOR trading below €STR in the front-end, it does highlight the illiquidity / credibility of EURIBOR as an instrument (see graph 3 below showing recent EURIBOR / €STR basis).
  • Market led – there is some evidence of a shift towards use of €STR over EURIBOR in the swaps market between banks, with the recent volatility in EURIBOR proving challenging; however the Pensions & Insurance sector in EU discount their liabilities off 6m EURIBOR as market standard (following lead of e.g. DNB[9] for Dutch Pensions and EIOPA[10] for Insurance industry), and this is unlikely to change until there is a firm plan for cessation of EURIBOR and the basis to €STR becomes fixed. 
  • EU official sector pressure – this is the big one. As we have seen with GBP and USD, when the official sector starts to apply pressure then things change. LIBOR transition was billed as ‘market led’ but the push via the Sterling RFR and ARRC[11] working groups really set the pace. So far, the EU RFR WG has focused its efforts on ensuring fallbacks are put in place and the transition from EONIA to €STR. There have been no references at all in the minutes to any sort of timeline for EURIBOR cessation, and indeed one member was at pains to point out that “the adoption of €STR in new cash products should be left to market forces since EURIBOR will continue to be available for use”.

Where does this leave us? Realistically, waiting for a change in tone from the EU official sector. 

For a more in depth analysis of this topic from a swaps trading perspective, see the article on EUR 3s6s basis written by Amir Niknafs on our Hedge Fund sales desk. He says:

One of the interesting rate themes over the past couple years has been the ongoing dislocation of the 3s6s Basis Curves. However, the past 2 weeks have started seeing a strong upward move in basis Fwds – we think something is afoot, and despite some of the correction, opportunities still abound.

Déjà vu all over again

Other topics in the EU space that will ring some bells for keen LIBOR watchers of old:

  • Fallbacks – as we saw in the UK and US, derivatives lead the way. Due to widespread ISDA Fallback Protocol adherence, fallbacks for derivatives referencing EURIBOR are already largely in place, falling back to the now well established €STR + a Credit Adjustment Spread (CAS) – more on that below. But of course as with GBP & USD in their time, the cash market lags far behind. And per recent EU RFR WG minutes that is especially true of loans, that continue to commonly refer to Cost of Funds as their fallback. 
  • CAS & 5YHM – the Credit Adjustment Spread (CAS) consulted on by ISDA for derivative fallbacks landed on the 5 Year Historic Median (5YHM) calculation method to establish the fixed spread between €STR and EURIBOR post cessation (see Bloomberg for published rates and methodology). This only gets ‘snapped’ at the point a cessation date is formally announced, at which point the 5-year lookback period is set. In graph 4 below we have modelled what that CAS would look like (red line in bps) for 3m EURIBOR depending upon when announced in the future (using either actual rates or forwards market once we run out of realised data). We’ve then compared against current forward basis market for €STR / EURIBOR as of today (blue line). In mid-2027 they converge around 17 bps, though then diverge again.
  • Term €STR – remember all the arguments about term rates (forward looking term rates based on RFRs)? Who will be the supplier, what will they be permitted to be used for? Well it’s starting to happen again for €STR. Refinitiv has had a prototype Term €STR rate available since Oct 2022, and European Money Markets Institute (EMMI) using ICE[12] as their calculation agent has announced EFTERM also in October 2022. As with Term SONIA[13] and Term SOFR[14], expect a bit of a bun fight over which emerges as the eventual standard, and for the official sector to say ‘the market should decide’. And we are a long way off deciding what they might be used for, or more importantly what restrictions might apply (Term SONIA was much more restrictive than Term SOFR). Main discussions initially will be around their use as one of the options in a waterfall fallback logic for cash products.

So EURIBOR reform is a confusing mix of don’t know and seen-it-before. Exactly when all this will become clearer is anyone’s guess, but just like your favourite box sets, with benchmark reform there is always another gripping series in the pipeline!

Data and graphs relating to this article

Graph 1 - EURIBOR Panel Bank Submissions - % of level 3 use in waterfall hybrid methodology

Source: EMMI January 2023 EURIBOR Transparency Indicators

Graph 2 - EUR Derivatives Traded Notional - Sep 2021 - Sep 2022

Source: ISDA / DTCC SDR (EU RFR Minutes Dec 2022)
Source: ISDA / DTCC SDR (EU RFR Minutes Dec 2022)

Graph 3 - 3M EURIBOR / €STR Spread since Sep 2022

Source: Bloomberg / NatWest Markets

Graph 4 - 3m €STR / EURIBOR Credit Adjust Spread Using 5YHM

Source: NatWest Markets

Abbreviations used:

[1] LIBOR - London Inter-Bank Offered Rate

[2] EURIBOR - Euro Inter-Bank Offered Rate

[3] IBOR - Inter-Bank Offered Rates

[4] ECB - European Central Bank

[5] FSB - Financial Stability Board

[6] EONIA - Euro Overnight Index Average Rate

[7] €STR - Euro short-term rate

[8] ISDA - International Swaps & Derivatives Association

[9] DNB - Dutch Central Bank / De Nederlandsche Bank N.V.

[10] EIOPA - European Insurance and Occupational Pensions Authority

[11] ARRC - Alternative Reference Rates Committee

[12] ICE - Intercontinental Exchange, Inc.

[13] SONIA - Sterling Overnight Index Average

[14] SOFR - Secured Overnight Financing Rate

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