The private sector working group of ECB on euro risk-free rates published the recommendations to address events that would trigger fallbacks in the Euro Interbank Offered Rate (EURIBOR)-related contracts, along with the €STR-based EURIBOR fallback rates (rates that could be used if a fallback is triggered). The working group also published recommendations for the permanent and pre-cessation EURIBOR trigger events. While there is no plan to discontinue EURIBOR, the development of more robust fallback language addresses the risk of a potential permanent discontinuation and is in line with the EU Benchmarks Regulation. The final recommendations consider the feedback from the two market-wide consultations on the draft recommendations for fallback rates to EURIBOR. ECB also notes that ESMA, as provided for in the Benchmarks Regulation, will supervise the administrator of EURIBOR as of 2022.
Key recommendations on EURIBOR fallback trigger events
- Contracts and financial instruments referencing EURIBOR should include provisions covering trigger events related to permanent cessation, temporary non-availability and non-representativeness (pre-cessation).
- Trigger events should be objectively drafted in precise terms and refer to events made publicly available by the regulatory supervisor of the EURIBOR administrator or the EURIBOR administrator.
- The date from which the fallback rate would apply after one or more of the trigger events has occurred should also be specified clearly in fallback provisions. The replacement date should occur on the date on which the benchmark has effectively ceased to be provided or is no longer representative, or any other point in time to be contractually determined. For such purposes, the relevant announcements from the administrator and/or the regulatory supervisor are expected to include the date of cessation, or, if applicable, the date from which the benchmark will cease to be representative.
- Market participants should seek consistency and use the same trigger events for all asset classes when developing and introducing fallback provisions in different financial instruments and contracts referencing EURIBOR, to the extent possible and appropriate. Market participants are encouraged to consider the risks derived from using different fallback trigger events.
- Market participants should consider at least those trigger events included in Article 23b(2) of the EU Benchmarks Regulation which grant EC the power to designate one or more replacement rates under certain circumstances and upon occurrence of one of four trigger events.
Key recommendations on €STR-based EURIBOR fallback rates
- Recommendations for a €STR-based term structure methodology for specific use cases. The working group considered two types of €STR-based term structure methodology as a component of EURIBOR fallback measures. The first is forward-looking term structures that would be based on quotes and transactions in the derivatives markets referencing the €STR and reflect market expectations of the evolution of the €STR during the upcoming interest rate period. They would be known at the start of the interest rate period. The second is backward-looking term structures based on simple mathematical calculations of the value of past realized daily fixings of the overnight risk-free rate by compounding the fixings over a given period of time. The working group considered the payment delay, the lookback period, and the last reset methodologies as viable for specific asset classes.
- Recommendations for a credit spread adjustment. To ensure economic equivalence between EURIBOR and the corresponding €STR term structures (forward-looking or backward-looking), the working group recommends calculating and applying a spread adjustment which reflects the value of a bank’s credit risk and other premia embedded in EURIBOR. The working group will refer to that as a spread adjustment.
- Recommendations for conventions when using a €STR-based backward-looking term structure methodology. For the cash products for which the working group suggests using a backward-looking term structure, the working group recommends that market participants use the compounded €STR average rates, as will be published by ECB as of April 15, 2021.
Keywords: Europe, EU, Banking, Securities, EURIBOR, Interest Rate Benchmarks, Fallback Provisions, €str, Benchmarks Regulation, Derivatives, Securitizations, ECB
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