Europe’s €STR rate part of global drive to achieve more reliable pricing in capital markets
Philip Stafford in London
The European Central Bank published the €STR rate for the first time on Wednesday © AFP
Global authorities’ efforts to move capital markets on to a sounder base took a step forward on Wednesday after European authorities launched a new benchmark based on overnight deals.
The new rate, called €STR, is intended to replace Eonia, a daily reference rate that reflects unsecured overnight lending between banks in the EU and which prices about €24tn of deals. The European Central Bank published the €STR rate for the first time on Wednesday, at a rate of minus 0.549 per cent based on Tuesday’s trading.
Watchdogs around the world argue that well-known interbank lending rates such as Libor and Eonia have outlived their usefulness because there are so few transactions that underpin the market, and banks no longer want to contribute to it.
More than $300tn of contracts are priced against Libor, for example, but the rate is largely composed by banks’ estimates rather than market transactions. Regulators would prefer investors and borrowers to price their thousands of loans, bonds and derivatives contracts on more reliable overnight lending rates.
The overnight rates are closely watched because the “front end” of European interest rate curves are derived from them. €STR is a “risk-free” rate and is based on deals concluded the previous day.
Several banks have been lining up deals referencing the new rate in preparation for the new benchmark. Earlier this week, JPMorgan and HSBC conducted a privately negotiated interest rate swap with a notional value of €100m and a week’s maturity. The European Investment Bank is also set to price a bond in coming days, with TD Securities acting as a bookrunner.
Eonia will still be published daily as a notional rate until the start of 2022 but it will be equal to €STR plus a fixed spread of 8.5 basis points. A basis point is 100th of a percentage point.
That means older, existing contracts will still have an economic value, said Murray Longton, principal consultant at Capco, a financial markets consultancy.
“In the next three to six months there’s unlikely to be much change in the market in general,” he said. “You aren’t forcing anyone to change the legal basis of the contract. When you stop deals transacted with Eonia [that] is when it matters.”
The pilot scheme for the past six months indicates that the new benchmark has traded at around five basis points below the ECB’s deposit rate of minus 50 basis points, according to UniCredit.
“Pre-€STR data suggest that this is a very stable benchmark and has displayed low volatility so far,” said Luca Cazzulani, deputy head of fixed income strategy at the bank.
Market participants are still testing new infrastructure intended to deepen liquidity in the market, such as swaps and futures contracts. Clearing of €STR-priced swaps is set to begin later this month.
European authorities have been further behind counterparts in the US, UK and Switzerland in developing a new rate, in part because a planned alternative rate was unlikely to meet the EU’s new standards.
Without reform, neither Eonia nor Euribor would meet tougher EU standards on benchmarks that come into effect in January.
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