ESMA and the EBA have issued a consultation paper on the future of Euribor. It’s not so much a consultation paper as a harsh criticism coupled with a strong demand for change. Now. While most of the recommendations are what you would expect (guidelines for submission, etc.), the report brings up some good points about what happens if benchmarks change mid-stream. This plays into broader concerns about what happens when benchmarks change, particularly certain benchmarks that are tied to trillions worth of outstanding financial contracts.
In their press release, ESMA and EBA cite some major deficiencies with Euribor:
• The Steering Committee, responsible for the governance of the rate-setting process, is not sufficiently independent as a majority of its members come from the panel banks;
• EEBF, as manager and administrator, does not assume sufficient direct responsibility for, and exercise direct control on, the rate-setting process, including the calculation agent (currently Thomson Reuters);
• No formal requirements exist for Euribor panel banks to have adequate internal governance, a code of conduct and conflicts of interest management in relation to the submission process;
• The definition of Euribor is not sufficiently clear as it is based on terms which create ambiguity; and
• The rates being quoted are not assessed sufficiently against evidence from real transactions.
The consultation document then goes into a range a proposed solutions to these ills, all of which could change Euribor in some ways. The document notes that “A benchmark user should develop robust contingencies for the unavailability of a benchmark within contracts referenced to it. The contingency provisions should be used in the event of occasional operational problems, or other market disruptive events, which lead to the benchmark not being reliable, calculated or published in the usual manner.”
We’ll accept as well known that legal contracts depend on the identity of a financial benchmark remaining the same for continuity. It wouldn’t do for LIBOR to become LIBAR midstream for example, as that would require re-papering possibly millions of financial contracts. Yet, ESMA and the EBA are suggesting that it is time for benchmark users to have a Plan B. A change in an underlying rate may well affect the pricing of an instrument or swap; its not clear that this situation has been thought through by most end-users of LIBOR or Euribor-based swaps, let alone by the banks that sell them.
“ESMA and EBA are conscious that any change to a benchmark’s framework (calculation methodologies and procedures) should be managed so as to ensure that any disruption to existing benchmark-referenced contracts are proportionate and minimised.”
So, ESMA and EBA want to improve Euribor but not actually influence the terms of the trillions worth of Euro that rely on them. This seems like a hard road to travel.
Given the difficulties that ESMA and EBA have identified, we’d posit that Euribor should be discontinued except for an important fact: the best benchmarks are local. ICAP’s new Repo indices capture country-specific rates for local investors. If Euribor is performing a similar service for Euro-area investors then it deserves to be reformed and maintained. If it ultimately comes to duplicate existing benchmark data then perhaps it’s time has come, and ESMA and EBA’s recommendations for a Plan B become the Plan A.
A link to the ESMA/EBA consultation document is here.