The ECB gives birth to a new benchmark...

Central banks and their respective regulators have been working hard to replace the Libor reference rates of old, following the discovery of widespread manipulation leading to fines running into many billions of dollars internationally.

This is no easy task, given the vast number of securities and derivatives tied to this benchmark (in Europe alone this figure exceeds a staggering EUR 22 trillion). Not only is it difficult to find a measure that is a fair representation of the price of unsecured money in the wholesale funding markets, there are now further challenges of price discovery with regard to credit and term premia, which Libor neatly packaged up in a single figure, or series of figures. None of the proposed new benchmarks fully capture the additional dimension that term provides, and would require a deep and reliable futures market in order to achieve this.

** €STR is born

Wednesday marked the first official publication of the ECB’s EUR libor replacement benchmark, the euro short-term rate (€STR). It is two years since its inception at the Governing Council where the timeline for go-live was set for pre-2020. It represents the Eurozone’s answer to the risk-free rate and an alternative benchmark to what is now considered its flawed predecessor, Eonia. As €STR is not based off quotes, rather, from real world transactions, the widely held view is this makes it harder to rig and thus represents true progress. Having the ECB as administrator has the buck stop at the highest of levels, further disincentivising abuse. Transactions are considered to be undertaken at arms-length, with the rate published representing the blended level from the previous trading day.

** Where is it now and what is it made up of?

The first published rate on 2 October for €STR was a slightly eye-watering (for those long of cash) -0.551. There were 28 constituent active banks, on a volume of EUR 33.5BN and just shy of 400 transactions. The five largest banks made up 52% of the volume. Going forward one would expect to see a higher number of participants and greater dilution leading to a cleaner (and hopefully less concentrated) average. For further information straight from the source regarding precise calculations click here. It will certainly be interesting to see how this develops and ties in with changes being made elsewhere in the world, with a great summary published by Reuters of how this sits within the global evolving framework here. We are always interested to hear the views of others, so please do feel free to reach out.