Shearman & Sterling LLP | FinReg | European Central Bank Publishes Report on the Risk Management Implications of the Euro Risk-Free Rates Provisions
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  • European Central Bank Publishes Report on the Risk Management Implications of the Euro Risk-Free Rates Provisions

    The European Central Bank has published a report on the risk management implications of the upcoming move away from the Euro Overnight Index Average (the overnight reference rate for the euro) and EURIBOR (the term reference rate for the euro) to alternative risk-free rates. Both EONIA and EURIBOR were identified as critical benchmarks for the purposes of the EU Benchmarks Regulation. As a result of this and recent benchmark manipulation scandals, EONIA will be phased out in favor of the Euro short-term rate (or “€STR”), which began to be published on October 2, 2019. EONIA will cease to be published entirely on January 3, 2022 and in the meantime the methodology for calculating EONIA has been redefined as €STR plus a fixed spread. The methodology for calculating EURIBOR has also been revised to be Benchmark Regulation-compliant and will be based on a €STR structure, to be implemented by the end of 2019.

    The ECB’s report considers the potential risks arising from the changes to EONIA and EURIBOR, primarily for banks but with some consideration of the risks the changes may pose to asset managers and insurance market participants. The ECB plans to publish a report on the financial accounting implications of the transition separately. The key risk management areas discussed in the ECB’s report are:
    1. General risk management considerations: banks, asset managers and insurance companies should quantify their exposures to EONIA and EURIBOR under their outstanding contracts and qualitatively assess the impact of the transition on the full value chain (including contracts, discounting, valuation and risk models), in order to determine the scale and nature of any mitigating actions they should take.
    2. Risk management impact analysis for the move from EONIA to €STR: the report considers that the transition from EONIA to €STR will give rise to valuation risk and market risk, as well as other financial and non-financial risks. The report provides proposed solutions for combatting such risks. For instance, a possible measure to combat valuation risk may be through the exchange of cash compensation, while market risks arising form the transition of products from EONIA to €STR could be dealt with by fixing dates for switching from EONIA to €STR in advance as far as possible and communicating with the clients to facilitate a smooth transition.
    3. Risk management impact analysis for the use of €STR fallbacks for EURIBOR: risks associated with introducing fallback provisions for the use of €STR as an alternative to EURIBOR include that such provisions may differ across product classes and there may be inconsistencies in the timing of fallback trigger events; the report recommends market participants consider such risks when drafting fallback provisions.
    4. Risk management considerations for asset management and insurance market participants: the report recommends that market participants carry out detailed impact assessments to identify the impact that the benchmark changes may have across the whole value chain and sets out some particular areas that asset management and insurance companies may wish to consider.

    View the ECB's report.

    View details of the EMMI's EONIA methodology.

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