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ECB begins transition of benchmark short-term interest rate

The new benchmark short-term interest rate reflects overnight borrowing costs of banks in the EU bloc

The ECB said that the fixing for Oct 1 was based on a volume of almost 36 billion euros completed between 32 banks in 432 transactions. PHOTO: REUTERS

New York

THE European Central Bank (ECB) began its official transition to a new benchmark short-term interest rate on Wednesday, as global regulators move away from tainted Libor gauges.

The new rate, known as ESTR, which reflects overnight borrowing costs of banks in the monetary bloc, fixed at -0.549 per cent for Oct 1, the central bank said on its website. The shift comes as similar actions are underfoot in sterling and dollar markets after a rigging scandal with the London interbank offered rate undermined confidence in indexes used as benchmarks for roughly US$370 trillion of financial products worldwide. In the euro area, regulators are trying to push market participants away from the traditional Euribor and Eonia measures.

By some measures, the euro area has lagged behind other regions in the shift from the much-maligned older benchmarks. US companies have been selling debt linked to the new American reference rate for nearly a year and in the UK, financial markets have begun to decisively migrate to a sterling overnight rate index.

The good news is that the move to ESTR may be helped by the ECB's strategy for switching from the former benchmark rate.

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"The transition to ESTR should be pretty straightforward given Eonia will now be computed as a tracker off this new rate," said Adam Kurpiel, a strategist at Societe Generale SA. "Euro money-market derivatives will also benefit from all the Eonia infrastructure. It should be much smoother than in the US where new markets had to be created from scratch" for their new benchmark - the secured overnight financing rate, Mr Kurpiel said.

The inauguration of the new rate follows ECB's years of preparation including the release of pre-ESTR data starting March 2017 through mid-September of this year.

Here's how it works:

  • ESTR rate published daily 7am London time for previous day;
  • European Money Markets Institute (EMMI) publishes Eonia using the new methodology at about 8.15am ( London time);
  • Eonia to be set at ESTR plus a fixed 8.5 basis points;
  • Eonia will be discontinued on Jan 3, 2022.

ESTR is already starting to gain traction with Germany's L-Bank this month pricing the first sale of syndicated notes tied to the ECB's new benchmark. Daily trading volumes in pre-ESTR have averaged about 37 billion euros (S$56 billion), with the rate staying mostly at about five basis points below the ECB's depo rate, according to UniCredit SpA.

The European Investment Bank may price on Wednesday a three-year floating-rate note linked to ESTR, according to a person familiar with the matter, who asked not to be identified because they are not authorised to speak about it.

The ESTR results suggest the ECB's deposit-rate cut last month - by 10 basis points to minus 0.50 per cent - is being passed on in full through the banking system. The ESTR reading released on Wednesday was in line with an estimate for -0.55 per cent from Christoph Rieger, head of rates strategy at Commerzbank AG. ESTR is a bank borrowing rate that relies on individual daily transactions. That compares with Eonia, a lending rate administered by EMMI that relies on voluntary contributions by banks. ESTR is a volume-weighted trimmed mean of overnight transactions. Counterparties include about 50 of the largest euro-area banks spread across 10 countries.

The fixing for Oct 1 was based on a volume of almost 36 billion euros completed between 32 banks in 432 transactions, the ECB said. The share of volume from the five largest banks was 54 per cent. It's not clear if the ECB's recent move to apply negative rates differently among various banks, known as tiering, will affect ESTR. Tiering comes into effect on Oct 30.

"Because ESTR is calculated as a trimmed mean, the impact of new flows will depend on their size relative to the volume of transactions that are eligible to calculate ESTR," said Luca Cazzulani, a strategist at UniCredit, in a note Monday. "One unknown issue is whether these new bids will go on top of existing ones or will crowd out less attractive bids." BLOOMBERG

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