The need for (an extension of their) transition periods!
The EU Benchmark Regulation (EUBR) sits at the heart of the key question around ESTER – will there be enough liquidity to transition, will EONIA really end in 2020 leaving only 3 months of ESTER publication and will the EU RFR reform end up tracking the same timeframe that’s been given to LIBOR (end 2021)?
The EUBR gives Administrators, Contributors and Users of benchmarks new obligations to follow if they wish to continue to be able to provide/contribute or use those benchmarks within the EU.
EUBR provided a two year transitional period to get onto the ESMA register of benchmarks and administrators. 1 January 2020 is currently scheduled as D-Day and is when the regulation is due to kick in with full force, with FCA's summary being very clear.
2019 – Key developments timeline:
So what’s the deal with the transitional provisions?
The EUBR transitional period may be extended but the extension may not apply to all categories of benchmarks.
- Critical benchmarks: those where the value of contracts underlying it is at least EURO 500 billion or is recognised as being critical by a Member State. These benchmarks are subject to more stringent rules in the regulation and presently there are only 4; EURIBOR, EONIA, LIBOR and STIBOR.
- Non-critical benchmarks: either deemed significant (value of contracts underlying it is more than EURO 50 billion) or non-significant (value of contracts underlying it is less than EURO 50 billion and it’s not a commodity or interest rate benchmark). These include third country benchmarks, i.e. benchmark administrators based outside of the EU and so not subject to EUBR. However for users in the EU to be able to use their benchmarks after the end of the transitional provisions, they have to be on the ESMA register otherwise it will be illegal.
What does this mean in practice?
- If the extension is granted for critical benchmarks: EURIBOR, EONIA, LIBOR and STIBOR can continue to be used post Jan 2020, all other benchmarks must be compliant.
- If granted for critical, non-critical (including third country) benchmarks: all can continue to be used until the end of the new transitional period. This would be a good outcome as there would be no day one impact and the status quo would continue, HOWEVER it could potentially just be kicking the problem further down the road…
- If no extension at all is granted: the market will need to brace itself for much disruption, uncertainty and potential last minute repapering. All benchmarks would have to be compliant by Jan 2020.
Where does this leave the EU RFR reform generally?
- In September 2018 the Euro RFR working group released their high level implementation plan and officially called on co-legislators for an extension of the transitional period for critical benchmarks for at least two years. Ironically the EU benchmarks (EONIA and EURIBOR) will not be ready in time to be compliant with the regulation.
- In November 2018 ISDA, GFMA, FIA and EMTA published a joint briefing strongly supporting the Euro RFR working group’s request and also requesting that the extension apply to non-critical benchmarks as well, arguing there is no clarity on how it will work.
- ESTER is the chosen Euro RFR and EONIA’s replacement but will not be published until October 2019 (highlighting the need for a transition period). HOWEVER a recent consultation on possible approaches for transition from EONIA to ESTER saw the Euro RFR working group recommend a recalibration approach: EONIA reformed to become EUBR compliant and having a spread attached to link it to ESTER and running alongside ESTER for two years (essentially marking EONIA the same rate as ESTER). So if the worst case scenario happens and no transition period extension is granted, this offers a glimmer of hope for EONIA at least.
- EURIBOR will continue and its methodology will be reformed to make it EUBR compliant. The Euro RFR working group held another consultation recently seeking views on determining an ESTER based term structure methodology as a fallback for EURIBOR. The working group’s recommendation was to use an OIS quotes-based methodology as the preferred forward-looking methodology.
BUT is the EURIBOR methodology reform just a reprieve rather an absolute solution? Many retail mortgages in the EU reference EURIBOR, making it difficult to order a transition now (hence reform). Once LIBOR transition focus calms, who knows where the regulator’s focus may be. It’s not beyond the realm of possibilities that they might then begin a push to begin to get the market to transition from EURIBOR to ESTER.
How does the EUBR and ISDA IBOR fallback reform link?
There are different drivers for each:
- EUBR is a regulatory requirement which is broad and encompasses all benchmarks. Transition is not the main focus here but the integrity of financial benchmarks as a whole.
- Last year ISDA published a consultation on the fallbacks to be used for IBORs. This is more related to transition as it’s about ensuring fallbacks are available in the event that an IBOR suddenly ceased. ISDA will publish a protocol later this year to allow the market to incorporate the new fallbacks in their existing transactions. For new transactions, the IBOR fallbacks will either be available as an amendment to the 2006 ISDA Definitions or available in the new 2019 ISDA definitions that ISDA will publish later this year (this is all dependant on timing of publication).
- With EUBR there is a requirement on users to have robust written fallbacks documented contractually in their transactions. This is where the ISDA Benchmark Supplement applies, providing a flexible path of options the parties would work through to find a replacement benchmark if the benchmark used (whether an IBOR or not) suddenly ceased or came off the ESMA register). BUT, if the benchmark in question is an IBOR, the IBOR fallbacks take precedence OVER the supplement in the event that a benchmark suddenly ceased. There is no ESMA register event in the IBOR fallbacks so if that is the reason for not being able to use the benchmark, the supplement would apply.
- Extending the transitional provisions would bring EUBR in-line with global RFR reform (LIBOR’s demise) which makes a lot of sense.
The EU led the charge for benchmark reform by introducing EUBR but in falling behind with the reform/replacement of the Euro rates, there is a real risk of global market disruption or continued uncertainty. There needs to be some concrete decisions in relation to the EU benchmark position post Jan 2020, and an extension to the transitional provisions of EUBR for all benchmarks. The market needs to know what is going to happen in order to be able to adequately prepare… sound familiar… ?
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