An overview of Q4 2019 market publications and an outlook ahead.
A word of welcome
It's 2020 and the race towards the finish line of risk-free rates (RFRs) implementation is well and truly underway, with EONIA being set to be discontinued after the end of 2021 and LIBOR continuity no longer being guaranteed from that same point in time onwards. It is not surprising then, that the fourth quarter of 2019 was a tumultuous one, bearing witness to key events such as €STR's first publication and the world's first €STR-denominated bond on October 2, discussion on if, how and what forward-looking term rates might look like, as well as a rapid flow of illuminating publications1, notably in the EU.
Whilst these publications covered a variety of topics related to the EU's Benchmark Regulation (EU BMR), one important message echoed across all reports: the clock is ticking for both benchmark providers but also benchmark users – including those located outside the European Economic Area (EU plus Iceland, Liechtenstein and Norway). Equally, from January 2022 onwards, EU-supervised entities can only use third-country benchmarks provided by administrators in a third country provided the European Commission has adopted (1) an equivalence decision; (2) the benchmark administrator has been recognized by an EU competent authority; or (3) the benchmark has been endorsed by an EU supervised entity.
We have therefore compiled a selection of publications (that are relevant from a legal standpoint) issued by a variety of market bodies in the final quarter of 2019, including a short summary of each report and, where relevant, our comments or other important matters that we think might be helpful for market participants. We round off our selection with a short outlook for 2020 and touch briefly on developments relating to the EU's BMR Review that closed for consultation at the end of 2019.
01 WORKING GROUP ON EURO RFRs
The Working Group on Euro RFRs (the Euro Working Group) was set up by the European Central Bank (ECB) in February 2018. Divided into seven sub-groups, it tackles all manner of issues and areas affected by the shift from the Euro Overnight Index Average (EONIA) to the euro short-term rate (€STR), as well as delivering helpful commentary on the Euro Interbank Offered Rate (EURIBOR)'s amended calculation methodology and its use of €STR as a fallback rate.
4 December 2019
The Euro Working Group publishes a timeline detailing its deliverables
During Q1 2020, the Euro Working Group will be occupied with the following: In relation to the €STR transition:
- Soliciting advice on risk management & financial accounting topics;
- Communicating & educating around the EONIA to €STR transition.
In relation to EURIBOR fallbacks:
- Preparing a consultation paper on a EURIBOR legal action plan in relation to new and legacy contracts;
- Analyzing suitable fallback benchmarks for cash & derivatives;
- Analyzing suitable transition/credit spreads per identified fallback;
- Preparing a consultation paper on fallbacks & credit spreads;
- Soliciting advice on risk management & financial accounting topics;
- Communicating & educating around the EURIBOR fallbacks.
The Euro Working Group also published a "standardized" but non-exhaustive checklist that some firms might find a useful tool for use with internal and external stakeholders as well as further development plans.
12 November 2019
Report by the Euro Working Group on €STR fallback arrangements
In this report, the Euro Working Group recommended several methods that together will provide market participants with sufficient contingency during the transition to €STR. These methods include closely following measures taken by the ECB in relation to its review of the €STR methodology as well as the ECB's recommended procedures in case of a potential cessation of €STR, in addition to using the fallback provisions provided by the Euro Working Group within the "EONIA to €STR Legal Action Plan" (published in July 2019).
Whilst these measures may in themselves be useful, it is insufficient to simply monitor ECB activity and wait for further developments to unfold: the timeline and implementation difficulty of the steps required to ensure a successful transition should not be underestimated, notably with respect to relevant exposures with retail clients or wholesale clients in jurisdictions (notably civil law ones) that require explicit documented client consent and in certain cases limit discretion in setting rates. Implementation of recommended actions ought to be commenced as soon as possible and it must be ensured that policies (e.g. in relation to a potential cessation of €STR) can actually be implemented where a trigger event occurs. The costs of this may be substantial but are outweighed by the risks otherwise incurred, including the expected supervisory scrutiny on firms' readiness that the ECB-SSM is expected to roll-out following its "Dear CEO" letter from July 2019.2
6 November 2019
Report by the Euro Working Group: High level recommendations for fallback provisions in contracts for cash products and derivatives transactions referencing EURIBOR
In this report, the Euro Working Group provided several recommendations that those entering into new contracts referencing EONIA/€STR should take into consideration.
Specifically, new contracts should:
- Include both permanent and temporary cessation trigger events, and should define the circumstances in which they will apply;
- Include EURIBOR fallback provisions which comply with the EU BMR, where applicable, and with any other applicable national or European law – market participants may wish to consider including generic language in their fallback provisions;
- Contemplate adjustments to address differences between the value of EURIBOR and the value of the fallback rate; and
- Where possible and applicable, include flexible provisions to facilitate the application of new fallback provisions and/or amend the consent levels required for future amendments to the agreements.
Whilst these comments are helpful, market participants must be aware that they are generic and may not apply to all scenarios, depending on the contractual documentation and features of the underlying product, as well as how local laws deal with the potential discontinuation of contracts. Such matters should be assessed on a case-by-case basis.
22 October 2019
Euro Working Group publishes communication toolkit
In order to enable a smooth transition, the Euro Working Group made available communication materials which interested parties could use in their own communication and education efforts. This communication toolkit currently consists of a list of frequently asked questions to help clear up any remaining uncertainties, a set of slides providing further information on the Euro Working Group and a checklist that may help all those affected by the transition review their progress.
Whilst the toolkit should not be seen as an instruction manual or a template from which to adapt contractual language, it is a helpful and clear overview of the direction in which market participants should be moving. We strongly recommend that market participants review this publication.
25 September 2019 (Q3)
Second roundtable on euro RFRs hosted at the ECB
The second roundtable on euro risk-free rates consisted of panel discussions pertaining to the following topics: (1) transitioning from EONIA to €STR; (2) establishing liquid €STR markets; and (3) €STR-based term structure methodologies as fallbacks for EURIBOR. Our Dentons colleagues were in attendance and compiled an in-depth report on the day's discussions. Please reach out to us if you would like to receive a copy.
02 EUROPEAN MONEY MARKETS INSTITUTE
The European Money Markets Institute (EMMI) is an international non-profit association founded in 1999 whose members are national banking associations in the Member States of the European Union. EMMI is the administrator of two important benchmarks: (1) EURIBOR, the money market reference rate for the euro; and (2) EONIA, the euro interbank overnight lending reference rate, which is currently being transitioned away from to €STR.
28 November 2019
EMMI confirms the successful completion of the phase-in of all EURIBOR panel banks to the hybrid methodology
EMMI confirmed successful completion of the phase-in of all panel banks to the EURIBOR hybrid methodology. The gradual phase-in commenced as far back as Q2 2019 in order to minimize operational and technological risks. Now that the implementation is complete, all panel banks have moved to new contribution and reporting guidelines. The EURIBOR Governance Framework (including the EURIBOR Code of Obligations of Panel Banks and the Benchmark Determination Methodology for EURIBOR) is now fully applicable.
The transition went seamlessly and this may bode well for the various transitions to RFRs. It must, however, be kept in mind that the latter transitions are far more complex and require action by a far greater amount of market participants.
16 October 2019
EMMI publishes its presentation on 'Building a €STR-based term structure' focusing on EMMI's approach in terms of:
- Methodology design;
- Infrastructure;
- Data quality control;
- Governance;
- Compliance;
- Distribution;
- Communication;
- Authorization.
Footnotes
1. Including ICMA's Quarterly Report for the First Quarter – Issue 56 – published January 10, 2020, which despite its specific focus of coverage contains items that are relevant for certain other sectors of financial markets and which is available here: https://www.icmagroup.org/assets/documents/Regulatory/Quarterly_Reports/ICMA-Quarterly-Report-First-Quarter-2020.pdf
2. See: coverage from our Eurozone Hub available here.
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