(Bloomberg) -- The European Central Bank begins its official transition to a new benchmark short-term interest rate Wednesday, as global regulators move away from tainted Libor gauges.
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 $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.
Early Wednesday the ECB will publish the euro short-term rate, or ESTR, which will reflect overnight borrowing costs of banks in the monetary bloc. By some measures, the euro area has lagged behind other regions in the shift from the much-maligned older benchmarks. U.S. companies have been selling debt linked to the new American reference rate for nearly a year and in the U.K., 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.
“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 (PA:SOGN) SA. “Euro money-market derivatives will also benefit from all the Eonia infrastructure. It should be much smoother than in the U.S. where new markets had to be created from scratch” for their new benchmark -- the secured overnight financing rate.
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 will work Wednesday and thereafter:
- ESTR rate published daily 7 a.m. London time for previous day
- European Money Markets Institute (EMMI) publishes Eonia using the new methodology at about 8:15 a.m. London time
- Eonia to be set at ESTR plus a fixed 8.5 basis points
- Eonia will be discontinued on Jan. 3, 2022
- Eonia to be set at ESTR plus a fixed 8.5 basis points
The ECB’s deposit-rate cut last month -- by 10 basis points to minus 0.50% -- seems to already have passed on in full through the banking system, with data signaling that the ESTR will fix at -0.55% Wednesday, according to Christoph Rieger, head of rates strategy at Commerzbank AG (DE:CBKG). That’s based on Rieger’s analysis of pre-ESTR data published Tuesday.
‘Unknown Issue’
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.
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.”
