Europe’s half-baked benchmark switch leaves some dissatisfied

It’s a case of ‘mission accomplished’ for the euro working group on risk-free rates – at least according to the now-disbanded committee’s narrowly defined objective.

Originally convened in 2018 by the European Central Bank, the group was tasked with replacing the flaky overnight rate, Eonia, with an alternative. Pensioning off fellow benchmark Euribor wasn’t on the agenda, in contrast to the ambitious switch-off of Libor in US and UK markets. 

“The only mission was to find a successor rate for Eonia,” says a working group member. “If we take this very narrow scope of the euro group, it’s mission accomplished now.” 

The group held its final meeting in Paris on November 13, drawing a line under benchmark transition efforts. Yet participants remain divided on whether its work went far enough. 

After 2021, when Eonia was fully replaced by the euro short-term rate, or €STR, some hoped the group would ramp up efforts to align more closely with new norms for risk-free rates in the US, UK and further afield. Yet group discussions around promoting €STR adoption in cash markets faltered, meaning participants will have to settle for a multi-rate outcome, and any associated asset-liability challenges that may create. 

“I’m a little disappointed,” says one benchmarks expert at a European bank of the group’s closure. “I feel that there’s still a need for a little regulatory stick to get the right outcome and fully transition.”

While progress has been made in adopting €STR in parts of the derivatives market, some think the momentum may now wane. 

“I would say it stops here,” says the working group member of growing €STR adoption. 

“The regulators were so important in the US and UK to push the market. Since we do not have this group any more, it’s a clear statement that it’s not on the agenda of regulators any more,” they add. 

Inertia could also hit transition hopes further afield. Many non-eurozone jurisdictions across the continent have been eagerly watching euro developments for cues. Some traders in the Nordic region, for example, had been hoping for a concerted push towards risk-free rates since new transaction-based methodologies, which aimed to align interbank rates with European Union benchmarks regulation, contributed to higher volatility in these fixings. 

“It doesn’t help at all,” says a swaps trader at a Nordic bank of the euro group closure. “When I saw the news, I was quite disappointed.” 

The shutdown also comes amid ongoing scrutiny of Euribor’s robustness. The European Money Markets Institute, which administers Euribor, recently completed a consultation for a methodology overhaul that would remove any need for expert judgement from panel banks. The body expects to release its findings next February.

Yet transaction data is no panacea. Members of the European Central Bank’s money market contact group, an influential committee of Euribor users, which includes the majority of the rate’s panel banks, recently noted that prospects for a pickup in unsecured interbank lending – the transactions which underpin Euribor – were limited. 

When the US market made its giant leap to the Secured Overnight Financing Rate, or SOFR, at the end of June – largely without hitch – many participants predicted the euro market would ultimately follow suit. After all, the US transition had already dragged some euro derivatives, such as cross-currency swaps, to the risk-free rate. €STR overnight index swaps represented almost half of euro swaps risk traded in the first half of 2023, according to data from Tradeweb. 

Yet the new rate has been largely ignored in cash markets, which remain stubbornly wedded to Euribor. What’s more, most lending agreements still don’t incorporate the robust €STR-based fallbacks, which formed a second key pillar of the working group’s objective. 

Those close to the working group say expectations of a wider adoption of €STR may always have been misplaced, given the polarised debate within the group. For example, members in Germany were generally more comfortable with a wider adoption of €STR in cash markets, thanks to the largely fixed rate nature of local loan markets. In Spain, where Euribor is the primary reference rate for mortgages, members fought hard to prevent any cumbersome repapering exercise. 

“There was a split of opinions that was anchored in the traditions of specific jurisdictions,” says the working group insider. “It’s always more complicated to do such a big reform in the euro area because we have segmented markets. I’d say it was hardly possible for the euro group to come up with a bigger reform.”

Those who predicted Euribor’s demise in the next five years may have to reassess their expectations.  But as the euro market’s outlier status grows – other jurisdictions including Canada, Mexico and Poland are severing ties with their own interbank rates in the coming years – it might not be a surprise if regulators put the euro group band back together for a revival tour at some point in the not-too-distant future.