FSB report highlights Eonia worries

A report by the Financial Stability Board has highlighted market worries about the health of the euro overnight unsecured rate – a key benchmark for swaps contracts in the eurozone.

“The robustness of Eonia is becoming a source of concern among some market participants,” says the FSB’s progress report on the reform of major interest rate benchmarks, released today (October 10).

“Eonia relies on the contributions of a panel of banks which voluntarily report their overnight unsecured interbank transactions. However, the panel of Eonia contributors has decreased from 33 banks at the beginning of the 2017 to less than 30 contributors over the summer. In addition, the Eonia volumes have occasionally reached historical lows in 2017, with volumes below €1 billion [$1.18 billion] in the course of May 2017 due to bank holidays in some countries,” says the report.

It says the decrease in Eonia volumes is being driven by lower funding needs “due to the level of excess liquidity in the euro area”, which market participants say is the result of the European Central Bank’s quantitative easing programme.

The FSB report’s comments come after a number of market participants had voiced concern about the health of Eonia. The benchmark is widely used as the rate at which the present value of future cashflows for euro interest rate swaps are discounted.

The falling numbers of panel contributors forced the rate’s administrator, the Brussels-based European Money Market Institute, to declare it a so-called critical benchmark in June under the EU’s benchmark regulation. This gives Emmi the power to compel panel banks to contribute to the rate if necessary.

A reformed version of Eonia, which could include a wider panel and catch a broader set of transactions, is being developed by Emmi separately. This is also a contender for replacing Euribor as the new risk-free rate (RFR) for euro swaps contracts – a process promoted by the FSB to wean the swaps market off relying solely on Libor as a reference rate.

In some currency areas, there are no plans to promote a transition to RFRs at this stage

Financial Stability Board

Concerns about the reformed rate led to calls for the ECB to step in and develop its own overnight rate, which it duly did on September 22. The central bank said it would be creating an unsecured overnight rate based on its money market statistical reporting (MMSR) data, and aims to finalise it by 2020. Market participants, however, have concerns about the ECB rate’s applicability to swaps contracts.

Emmi is also developing a secured, repo-based rate that could function as an RFR for swaps contracts, but many market participants are not yet convinced.

Elsewhere, the FSB report highlighted the importance of a speedy transition from current Libor-based contracts to those referencing the new RFRs, given the lack of certainty surrounding the long-term viability of some of the so-called Ibor rates.

A July 27 speech by Andrew Bailey, chief executive of the UK Financial Conduct Authority, announced a deal with panel banks to voluntarily submit quotes until the end of 2021. From then, the regulator would give up its powers to compel banks to submit to the various Libor panels – at which point banks may leave the panel, meaning Libor rates may cease to exist.

Despite efforts, European regulators have been unable able to strike a similar deal for Euribor, which is also designated a critical benchmark in the EU. “Limited progress has been made to date on migration from the major Ibors to these RFRs, even where they are available. In some currency areas, there are no plans to promote a transition to RFRs at this stage,” says the report.

“For those currencies that intend to more actively promote the use of RFRs as an alternative to Ibors for some products, it is important that momentum is maintained to fulfil the FSB’s recommendations regarding RFRs,” the report adds.