The Overhaul of Euribor 2024
In October 2023 a new methodology to calculate Euribor (Euro Interbank Offered rate) was proposed by European Money Markets Institute (EMMI)*, where the use of “Expert Judgement” to determine the rate would be discontinued. The consultation paper was found to have broad support and therefore from mid-May 2024 Euribor will be calculated on a different basis. The move to the new calculation will be implemented in a phased manner where panel banks** over a period of six months will be migrated to the new methodology (transaction based) one by one.
*European Money Markets Institute (EMMI) – Along with the introduction of the Euro the EMMI was founded in 1999 by the national banking associations of the Member States of the European Union. The EMMI is an international not-for-profit association, facilitating the smooth functioning of the euro money markets. In July 2019 the EMMI was granted an “Authorisation” by their supervisor – The Belgium Financial Services and Markets Authority (FSMA) – for the administration of Euribor under BMR (Benchmark Regulations of the European Union)
** Panel banks – These are banks (19 banks with top credit ratings and ethical standards) from across Europe that have a place on the panel of the administrator of Euribor (EMMI) for contributing Euribor submissions which are eight different rates based on loans with maturities from one week to twelve months.
The underlying or core reform dismantles the requirement for panel banks to provide bespoke estimates in certain or unusual circumstances when actual borrowing or lending does not take place. The move will also potentially allow for more banks to contribute to the Euro benchmark which is of course utilised in many products from car loans to mortgages which is valued in the trillions of euros. There are currently three levels that determine Euribor, as outlined below.
· Level 1 – This consists of contributions based solely on transactions in the underlying tenor (Interest rates for 1 week, and 1, 3, 6 and 12 months), from the prior Target Day, using a formulaic approach provided by the EMMI.
· Level 2 – This level is divided into three separate or sub-levels,
· Level 2.1 – This is based on a linear interpolation (helps builds new data points within the range of a set of already known data points), which includes a spread adjustment from level 1 contributions at adjacent defined tenors and is only applicable to the 1, 3 and 6 month tenors
· Level 2.2 – This is based on qualifying non-standard maturity transactions (as defined by the EMMI) where the maturity date falls between two defined tenors and can be used to determine a submission/contribution at the two nearest defined tenors. This level is only applicable to 1, 3, 6 and 12 month tenors.
· Level 2.3 – This is based on market-adjusted Level 1 submissions/ contributions from prior fixing dates or historical Level 1 data, and is only applicable to the 1,3,6 and 12 month tenors.
· Level 3 – This consists of submissions based on transactions from a range of markets closely related to the unsecured money markets. Each panel bank uses specific data and tailor-made modelling techniques depending on their own funding models.
The new methodology is intended to reduce the operational burden on panel banks who’s current approach is to develop internal processes including a framework for governance for making presumed Level 3 submissions based on expert judgement. Level 3 will, under the new methodology, be scrapped saving panel banks millions of Euros in the costs of meeting this level’s requirements. However, this means that level 2 will be expanded to include additional banks and from a technical standpoint enlarging the starting point of its calculation and redefining the Market Adjustment Factor (MAF) to better reflect perceived credit risks and changes in interest rates. The MAF is calculated based on changes in the closing prices of the ICE (Intercontinental Exchange) Euribor futures contracts for the quarterly months.
