Lingering Euribor may hit €STR futures prospects

Bourses question viability of euro RFR contracts as Euribor reform efforts remove transition incentives

Regulators in the eurozone could be hobbling their own chances of building liquidity in the forthcoming euro short-term rate, or €STR, via their parallel efforts to keep Euribor alive – perhaps permanently – causing some exchange operators to question the commercial viability of launching products tied to the new benchmark.

Euribor is on a divergent path to its sterling Libor cousin, which will be left to die after 2021 when the UK’s Financial Conduct Authority will stop compelling banks to submit marks to its rate-setting panel. The euro interest rate benchmark, however, administered by the European Money Markets Institute, is undergoing surgery to prolong its life – an effort which has garnered robust support from regulators including the European Central Bank, which will begin publishing the new risk-free rate in October.

For derivatives exchanges – some of which rushed to offer futures on dollar and sterling risk-free rates – the incentives to launch similar contracts linked to €STR are less clear.

“The Bank of England has done a brilliant job around how transition will work, but from a personal perspective, it’s much harder to understand what the commercial opportunities are in euro,” said Andy Ross, CEO of CurveGlobal, at an industry event organised by the Futures Industry Association earlier this month. “It’s much less clear what the path forward is… when we have Euribor still appearing to exist in a slightly different format.”

UK regulators including the Bank of England (BoE) and the FCA have urged sterling market participants to prepare for Libor’s death by transitioning to its successor rate, the sterling overnight index average (Sonia). Similar efforts afoot in the US are encouraging participants to transition to the secured overnight financing rate (SOFR).

By contrast, benchmark reform in the eurozone lags behind and is now heading in a direction favoured by Australia and Japan, where risk-free rates and rehabilitated Ibors look set to coexist indefinitely. Cornelia Holthausen, deputy director-general of the ECB’s Market Operations division, told Risk.net in a recent interview that market participants could stick with Euribor “forever” if ongoing reform efforts are successful.

Speaking at the same industry event, Lee Bartholomew, head of derivatives product research and development for fixed income at Eurex, agreed the European approach is creating uncertainty.

“There is less clarity on the road ahead in terms of the communication that you get from the ECB. What you had in the US was a very clear direction. In New York, you had people from governing bodies sending a very clear and consistent message. You can perhaps argue you don’t get the same clarity out of the ECB and Europe, which therefore muddies the waters in terms of the direction ahead,” he said.

Futures uncertainty

For exchanges, Europe’s regulatory inertia on transition means futures offered on the new rate could lie dormant, gathering dust on inert order books for years to come.

“There’s no transition plan. On the one hand, Euribor isn’t going away and on the other hand, people are being encouraged to trade €STR. It’s really challenging to know the upside of launching something that no one is being properly incentivised to trade,” says an official at one derivatives venue.

Primary candidates for an €STR futures launch include Eurex, CurveGlobal and Ice Futures Europe, which already list Euribor contracts. Ice is the dominant player in euro-denominated short-term interest rate contracts, with a roughly 90% share of the €5 trillion ($5.7 trillion) market by open interest. The European arm of the US exchange group flagged its intention to offer futures on the new euro risk-free rate in August 2018, alongside an announcement of its SOFR futures launch in the US.

“Ice also intends to offer futures on euro and Swiss franc alternative risk-free interest rates once the underlying benchmarks on these currencies become available,” the exchange said in a statement at the time.

Speaking on a Risk.net webinar in May, Eurex’s Bartholomew said the Frankfurt exchange would aim to offer products linked to the new rate shortly after its publication, including listed instruments and clearing for over-the-counter swaps.

A spokesperson for Eurex confirmed the exchange was “looking into” €STR futures but declined to comment further.

CurveGlobal, which already lists Sonia futures, has yet to confirm whether it will venture into the new rate.

“We’re monitoring this closely and working with the market to assess demand,” says Ross.

CME does not yet have plans to join the €STR battle – if there is one to be fought. “CME Group is focused on developing our SOFR products and does not offer euro interest rate futures contracts,” says Agha Mirza, global head of interest rate products.

The industry is unlikely to see a repeat of the bun fight witnessed for Sonia futures liquidity. A tough UK regulatory tone on transition sparked fervent competition among exchanges, with CME, CurveGlobal and Ice Futures Europe all battling it out for control of the new-look sterling money market.

Various contract flavours have emerged as the runners and riders look to differentiate themselves, including one-month, three-month and MPC contracts – whose end dates coincide with meetings of the BoE’s monetary policy committee – as well as inter-commodity spread contracts, which allow clients to trade the basis between Libor and Sonia.

Going by open interest, Ice seems to be winning the race, hosting 65% share of the £120 billion ($152 billion) outstanding as of June 20. CurveGlobal meanwhile has 23% and CME 12%, according to data reported by the exchanges.

In the US, CME is the runaway leader in SOFR futures, with 90% of $465 trillion in open interest. Ice holds the remaining 10%.  

While Euribor is set to stick around indefinitely, Eonia – the eurozone’s existing overnight rate – is on the chopping block. The rate is deemed too flaky to pass muster with the EU’s forthcoming Benchmark Regulation and will be recalibrated as €STR plus a spread once the new rate is published.

For Eurex and Ice Futures Europe, which currently list futures on Eonia, the rate’s demise is likely to pass unheralded; listed Eonia contracts are not actively traded and open interest at both venues stands at zero.

I think they want to move Eonia to €STR and then see how the UK and US efforts fare before deciding what to do with Euribor in the long term

A derivatives exchange official

Greater scope for transition may reside in OTC euro swap markets. As the rate used for discounting of future cashflows and price alignment interest for euro interest rate swaps, Eonia is actively traded OTC. Data from LCH show €22 trillion notional of cleared euro overnight index swaps on SwapClear.

LCH is expected to begin offering €STR swaps clearing from January 2020, and preparatory work is already underway.

Attempts to breathe new life into Euribor are rooted in the rate’s importance in retail mortgages, which would be difficult to transition to an alternative in an efficient manner. The new hybrid methodology aims to increase the number of transactions underpinning the rate and reduce reliance on so-called “expert judgement”. A second pillar of improvements centres around enticing more banks onto submission panels.

Some market participants remain sceptical, particularly given the departure of National Bank of Greece and Banca Monte dei Paschi di Siena since the start of this year, taking the total number of submitting entities to 28.

The exchange official likens Euribor’s rehabilitation to “hunting unicorns”, noting that while the panel of banks is already wider than US dollar and sterling Libor panels, the number of transactions underpinning the rate is lower.

“I think they want to move Eonia to €STR and then see how the UK and US efforts fare before deciding what to do with Euribor in the long term,” he says.