22.01.2020

European Central Bank Working Group publishes report on €STR ‘Fallback Arrangements’

The Private Sector Working Group on Euro Risk-Free Rates set up by the European Central Bank has published a Report on the Euro Short-Term Rate (€STR) ‘Fallback Arrangements’.

The Report guides Supervised Entities on potential options for complying with Article 28.2 of the EU Benchmarks Regulation when using €STR, as the Euro Risk-Free Rate, in their Contracts.

Article 28.2 of the ‘BMR’ requires Supervised Entities to have robust written plans in order to set out actions they would take in an event that the Benchmark materially changes, or ceases being provided. Those plans should be reflected in the contracts between Firms and Clients. When it is feasible and appropriate, the plans should include one, or several, Benchmarks which can be used when the original Benchmark is no longer provided, indicating why such Benchmarks would be suitable alternatives.

The Report explains that the Working Group has assessed two options for possible ‘Fallback Arrangements’ for €STR products. Based on the assessment the Working Group has decided to recommend that Market Participants consider the measures that might be taken by the ‘ECB’ as part of the regular review of the €STR methodology, as well as the Policies and Procedures to be followed in the event of the possible cessation of the €STR, together with the ‘Fallback Provisions’ provided by the Working Group in the Euro OverNight Index Average (‘EONIA’) to €STR Legal Action Plan. The Working Group is of the opinion that this combination will provide sufficient contingency as ‘Fallback Measures’ for the €STR.

Following the recommendations from Financial Stability Board on ‘Reforming Major Interest Rate Benchmarks’, the EU ‘BMR’ entered into force in June 2016. Based on the implementation of the ‘BMR’, the European Money Markets Institute conducted a review on ‘EONIA’ and concluded that this would not become ‘BMR’-Compliant. The ‘BMR’ Transitional Provision requires ‘EU’ Firms to only use Registered or Authorised Benchmarks that comply with the ‘BMR’ in new contracts as of 1 January 2020. ‘EONIA’ in its original form can no longer be used in new contracts from this date.

All Firms dealing directly, or indirectly with contracts highlighting the usage of the €STR, or which have any previous contracts falling under the Euro Interbank Offered Rate (‘EURIBOR’), or the ‘EONIA’, should ensure they understand their Risk Exposure (and Mitigants) and Compliance Obligations in any ‘Fallback’ Situation and should prepare and establish relevant Policies, Processes and Procedures and an Implementation Plan with the required Actions and Timeline(s).

Firms are advised to review the Report from the Working Group when using €STR in contracts, seeking input from Risk and Compliance, Finance, Operations<Legal and Change Management Functions, ensuring Executive / Senior Management Teams, Board Members, Risk and Compliance and Audit Committees are appraised and maintain oversight, as part of Internal Governance Arrangements.

The Working Group highlights the application of the recommendations by the Working Group will be voluntary for all Market Participants. Each Market Participant will need to make its own independent decision, taking account of their individual circumstances and whether it wishes to voluntarily adopt all / any of the recommendations and apply them in their written plans and contracts.

Further information:
To read more, please follow this link:

EONIA to €STR Legal Action Plan
https://www.ecb.europa.eu/paym/pdf/cons/euro_risk-free_rates/ecb.eurostr_eonia_legal_action_plan_20190716.en.pdf

ECB working group report on €STR fallback arrangements
https://www.ecb.europa.eu/pub/pdf/other/ecb.wgeurofr_eurostrfallbackarrangements~86a6efeb46.en.pdf