1.3 Money market reference rates revised

The Eonia and Euribor money market reference rates were revised in 2019. The European Central Bank's new overnight benchmark the €STR joined the Eonia as from October 2019. At the same time, the Eonia was fixed to the €STR. The Euribor rates, in turn, had their specification reformulated. The new methodology was fully implemented during the fourth quarter of 2019.

Reference (or benchmark) rates are publicly accessible interest rates that serve, among other things, as a basis for loans, derivatives and other financial contracts. They generally reflect the price of borrowing on a specific market.

The reference rates most familiar to Finnish households are the Euribor rates, which are used, among other things, to determine the prices of housing loans. Together with the Eonia, the Euribor rates are the most widely used reference rates across the EU. Both the Eonia and the Euribor rates were revised in 2019.

New benchmark rate €STR joins Eonia

The European Central Bank (ECB) published its new overnight benchmark rate the €STR (euro short-term rate) for the very first time on 2 October 2019.

The €STR was introduced alongside the European Money Market Institute's (EMMI) Eonia rate as a measure of the average overnight interest rate in the euro area. At the same time, the Eonia was set to a fixed spread of 8.5 basis points over the €STR until its discontinuation on 3 January 2022.

This revision is a consequence of 2016's Benchmark Regulation, which imposed additional requirements on reference rates. The almost 2.5-year transition period from the Eonia to the €STR is meant to ensure that the replacement of the overnight reference rate on the money markets will proceed smoothly.

The €STR as a measure of overnight interest rates

The €STR measures the average interest rate that banks must pay for unsecured overnight euro-denominated credit on wholesale markets.

The €STR is an important benchmark rate especially for the functioning of derivatives markets. It also yields information on the pass-through of monetary policy to the money market.

The €STR is based on the ECB's statutory money market statistical reporting (MMSR) dataset, where 50 large European banks must submit reports of their daily money market transactions. The €STR is calculated on the basis of unsecured overnight loans taken out by the reporting banks that are at least EUR 1 million by volume. The rate is calculated as a volume-weighted mean of the middle 50% of the volume-weighted distribution of rates, rounded to the third decimal.

The ECB publishes the €STR every operating day of the TARGET2 payment system at 08.00 Central European Time. The published rate always reflects the previous business day’s money market rates.

With the abundance of excess liquidity, the €STR is below the ECB’s deposit facility rate

With the prevailing excess liquidity in the banking system, the €STR held steady below the ECB's deposit facility rate. Since its initial publication on 2 October, the €STR averaged -0.54% in 2019. The spread between the €STR and the ECB deposit facility was about -0.04 percentage points, or -4 basis points. By contrast, the Eonia averaged about 3 basis points higher the ECB's deposit facility rate in 2019, before it was fixed to the €STR from the beginning of October (Chart 7).

The spread between the €STR and the Eonia is due to a difference in methodology. The computation of the €STR also includes loans received by banks from non-bank financial institutions. Only banks have access to the Eurosystem's deposit facility. Other financial institutions, in turn, must deposit their funds with the banks. Because of the abundance of excess liquidity in the banking system, the banks do not have to compete for these funds to fulfil their minimum reserve requirements and may instead charge financial participants for these deposits by remunerating them below the ECB's deposit facility rate.

Bank of Finland involved in €STR quality control

The Eurosystem monitors the accuracy of the data used to calculate the €STR, so that the benchmark rate would reflect the prevailing level of overnight interest rates as accurately as possible. The Bank of Finland contributes to the quality management process by monitoring the data submitted by Finnish reporting agents. In 2019, Nordea was the only MMSR reporting agent out of all the Finnish banks.

In addition to quality control, the Bank of Finland participated closely in the Eurosystem’s policy preparation working groups for the reference rates.

Euribor calculation methodology revised

Similar to the €STR, the Euribor reference rates measure the average cost of unsecured euro-denominated overnight loans on the wholesale markets. The Euribor rates, which are familiar to Finnish households from housing loans, are also vital to the functioning of derivatives markets.

In addition to the Eonia, the European Money Market Institute (EMMI) also administrates the Euribor rates. EMMI publishes the Euribor for maturities ranging from one week to one year every TARGET2 business day at 11:00 Central European Time.

Before their revision, the Euribor rates did not meet the standards of 2016’s Benchmark Regulation, as they were based solely on expert evaluations by panel banks and not on actual market transactions. In response, EMMI devised a new methodology for calculating its Euribor quotations. It gained the approval of Belgium's Financial Services and Markets Authority (FSMA) at the beginning of July.

The revision uses a hybrid methodology in which a panel bank's quotation for each Euribor rate is based primarily on settled loans. If the amount of settled loans is insufficient, the quotation is also based on earlier transactions or on loans with a different maturity to the Euribor in question. Only in the failure of the above will the quotation be based on other relevant market data or the expert judgement of panel banks.

Once the banks’ quotations have been received, the middle 70% are used to calculate the Euribor by taking the arithmetical mean of the quotations and rounding to the third decimal.

New methodology adopted in full during last quarter of 2019

Panel banks began adopting the new calculation methodology in the second quarter of 2019. In November EMMI announced that it had completed the transition phase.

The daily volatility of the Euribor rates seems to have increased around the time that the new methodology was adopted. However, some of this volatility is likely due to shifting expectations concerning the key ECB interest rates at end of 2019 (Chart 8).