Money market reform focused on safety rather than term premium

Time is pressing – that is the unanimous opinion of the working group for a risk-free reference interest rate in the Eurozone. The current overnight reference interest rate in the Eurozone, the Eonia (Euro OvernIight Index Average), may only be used for new contracts until the end of 2019 and after that for existing contracts, if need be. The ECB considers ESTER (Euro Short-TErm Rate) to be the hottest succession candidate, even if the decision on this has yet to be passed. However, ESTER is trading at an average nine basis points lower than the Eonia which could hamper the transition. While a spread on ESTER that, for example, declines over time would ease the reference interest rate transition, conceptual simplicity and the tight time frame argue for a clean cut.

Unlike Eonia, Euribor (Euro InterBank Offered Rate) could continue as a benchmark beyond 2019, but this does not mean that its long-term survival is assured since the planned new hybrid fixing cascade of 1) transactions, 2) developments in related markets and 3) expert estimates is probably based too greatly on the last fixing level (expert estimates) and might therefore fail to meet the valid requirements for financial market benchmark indices over the long term. As a final consequence, the Euribor will most likely share the same fate already awaiting the Libor (London Interbank Offered Rate) and disappear from the scene in the coming decade. This would have far-reaching consequences beyond the banking sector. Libor, Euribor et al were used in the past not only in interbank trading but also for bonds and loans, in risk controlling and in corporate accounting. To ease the transition into the new reference interest rate world for these users of Euribor and Libor rates as well, forward rates based on the new reference interest rate (probably ESTER) would probably be useful in the medium term.  Money markets that will sooner or later be affected by the foreseeable end of the Libor after 2021 have already started developing derivative money market curves on the basis of overnight rates.

Derivative OIS (overnight index swaps) or futures markets most likely form the best basis for benchmark-compliant forward rates if there is sufficient underlying sales activity while a backward-looking fixing approach could serve as a fallback if the derivative forward interest rate fixings fail due to insufficient sales. This provision would then also apply to existing Libor contracts that go beyond 2021. At the end of this money market reform process, the face of money markets worldwide will have changed (with the possible exception of Australia), with the focus no longer being placed on a term premium but on the robustness and freedom from risk of the new reference interest rates.

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