The Rise of €STR

To many it sounds like an idyllic Greek resort or a windswept Scottish island but, in the financial world, EONIA stands for Euro Overnight Index Average – the daily reference rate that tracks the interest charged on interbank lending in the European Union. It is calculated by the European Central Bank (ECB) based on data received from 28 panel banks in the EU. But shortly EONIA will be no more. It will be replaced by €STR – the Euro Short-Term Rate.

€STR will be administered by the European Money Markets Institute (EMMI); a not-for-profit Belgian company with members from the national banking associations within the EU. The reason for moving to €STR is quite simply a new methodology that is not subject to potential manipulation by some of the 28 panel banks. These are the same issues that dogged other benchmark rates like LIBOR and EURIBOR. But critics argue that the workings behind €STR will be more opaque. This is concerning!

The accurate and transparent calculation of €STR is important for everybody (and not just high financiers) because it forms the very basis upon which the price of all loans are calculated. This is akin to a good solid foundation going into a multi-story building. None of the layers built on top will be compromised. Having a dodgy construct at the core leaves the whole edifice vulnerable. But, nonetheless, EMMI, an un-elected body, has been tasked with building the foundations for €STR.

€STR will have a very extensive reach. It will impact on pretty much every interest-rate product that’s denominated in Euro. Given the vast extent of financial contracts that are currently in place the transition from EONIA to €STR is likely to take several years. But the recommendation is that, for all new contracts, the changeover should happen next week 02 October. During the transition period EONIA will continue to be used for legacy contracts, which will undoubtedly cause confusion. EMMI has recommended that all existing financial contracts using EONIA should be amended to €STR and that the transition period should end by 31 December 2021.

Readers may find this of academic importance only. But MMPI fears that the new methodologies employed will grant the control of a very important reference rate to a company with the interests of its members at heart. It will be difficult for EMMI to display true transparency and to prove, beyond reasonable doubt, that it has no conflict of interest in these matters.

Conflicting interests lie at the heart of many dubious business activities. They place an inordinate burden on organisations, not only to act honestly and fairly, but to be seen to be doing so. Having an organisation, whose members are solely EU banking associations (whose own members are bank officials) officiating on a benchmark interest rate that directly impacts the price of banking products is somewhat duplicitous. We wish EMMI the best of good fortune in their efforts to convince market participants of their independence. MMPI remains a doubter!