The European Money Markets Institute (EMMI), which is the administrator for the Euro Interbank Offered Rate (EURIBOR), has published its second consultation paper on a hybrid methodology for EURIBOR. This is important because it sets out further details regarding the new EURIBOR methodology and indicates that EMMI is confident that EURIBOR will comply with the requirements of the EU Benchmark Regulation, such that “EMMI expects to become an authorised benchmark administrator” before January 2020. 

Why does EMMI need to be an authorised administrator before January 2020?

Under the EU Benchmark Regulation, EMMI will need to apply for authorisation by 1 January 2020. If EMMI’s application for authorisation were refused, then EU supervised entities would be unable to use EURIBOR in certain contracts (including new, and potentially legacy, financial instruments and contracts). EMMI’s confirmation that it expects to become an authorised administrator in accordance with the EU Benchmark Regulation is therefore a welcome development. 

When will EMMI apply for authorisation? 

EMMI will apply for authorisation by Q2 2019 and expects to be authorised before 1 January 2020. 

What is the hybrid methodology and why is it necessary? 

EMMI has been taking steps to revise the methodology according to which EURIBOR is calculated in light of various interest rate reform initiatives, including the Financial Stability Board’s (FSB) report on Reforming Major Interest Rate Benchmarks. The FSB’s report suggests that interbank offered rates, such as EURIBOR, should be underpinned with transaction data to the greatest extent possible. EURIBOR is currently calculated based on quotations from panel banks and expert judgment. 

EMMI initially tested a fully transaction-based methodology but concluded that this would not be feasible due to the lack of underlying transactions. The hybrid methodology provides that panel banks should base submissions on the following waterfall:

  • Transactions in the “Underlying Interest” at the relevant tenor from the prior TARGET day (“Level 1”).
  • Transactions in the “Underlying Interest” across the money market maturity spectrum and from recent TARGET days (“Level 2”). The waterfall for submissions at Level 2 is further sub-divided into the following three approaches: (i) adjusted linear interpolation between submission rates in adjacent defined tenors (“Level 2.1”), (ii) transactions at non-defined tenors (“Level 2.2”) and (iii) eligible transactions from prior dates (“Level 2.3”).
  • Transactions in the “Underlying Interest” and/or other data from a range of markets closely related to the unsecured euro money market using a combination of modelling techniques and the panel bank’s judgment (“Level 3”).

Once panel banks have made their submissions based on the hybrid methodology, EURIBOR will be calculated based on the trimmed mean of those submissions. This involves discounting the highest and lowest 15% of submitted rates and calculating an average of the remaining rates.

What does the consultation say? 

EMMI’s first consultation on the hybrid methodology sought feedback on the proposed methodology. Following this, EMMI undertook a 3-month test of the hybrid methodology. The second consultation summarises the results of this test, based on submissions made by 15 of the 20 EURIBOR panel banks during the test phase, and asks for feedback on EMMI’s consequent proposals.

In particular, EMMI asks for feedback on the following aspects of the hybrid methodology: 

  • The anonymised indicators it plans to publish to increase transparency regarding the determination of EURIBOR.
  • EMMI will define “maturity windows” within which the maturity of transactions must fall in order to count as Level 1 transactions. It asks for feedback on the proposed length of these “maturity windows”.
  • The exclusion of trades with non-financial corporate counterparties from eligible Level 1 transactions.
  • The inclusion of transactions indexed to the euro risk-free rate (currently EONIA and, once available, ESTER)1 as eligible Level 1 transactions (banks were required to report the fixed-rate equivalent price for these transactions using the overnight index swap market curve during the test phase).
  • The introduction of a minimum size threshold of EUR 20 million for eligible Level 1 transactions.
  • The decision not to introduce a threshold on the number of eligible transactions a panel bank must have for a Level 1 submission to be made.
  • Level 2.1 submissions will be calculated by applying a spread adjustment factor to the linearly interpolated rate. EMMI asks for feedback on the proposal that this spread should be determined based on the prior 5 days of published EURIBOR fixing rates at each of the tenors.
  • Level 2.2 of the hybrid methodology generally.
  • Level 2.3 submissions will be calculated by applying a market adjustment factor to the submission rate on the most recent day at that tenor when a Level 1 submission was made. EMMI asks for feedback on the proposal to use a 4-day lookback period to find a previous Level 1 submission. 

Where can I find more information? 

EMMI’s second consultation paper on a hybrid methodology for EURIBOR can be found here:

https://www.emmi-benchmarks.eu/assets/files/D0373- 2018%20Second%20Consultation%20Hybrid%20Euribor_full.pdf

The consultation is open until 30 November 2018.