The European Overnight Index, or EONIA, should cease to be published definitively from January 3, 2022, because the EONIA does not meet the requirements of a financial “benchmark” under the European regulation on indexes. reference.1.
In a sense, the EONIA has already ceased, because as of October 2019, the EONIA has not been independently determined but rather has been published as a rate equal to the Euro Short-Term Rate ( € STR), increased by 8.5 basis points.
EONIA is a particularly important rate for the OTC derivatives market, as it is the most common interest rate applied when the euro cash collateral goes under an ISDA credit support annex (CSA ). The significance of the demise of EONIA is more than the mere fact that the interest rate payable under an affected CSA will cease to exist and will therefore have to be replaced. It is also that the CSA interest rate is the rate by which the cash flows on the derivatives which are subject to it must be discounted when they are valued.
The European Union has consulted on a partial legislative solution to deal with the demise of EONIA, but this only applies to contracts where the applicable law is that of a country in the European Economic Area (EEA ) or both parties to the contract are based in the EEA and the law of the contract is that of a third country which does not provide for an orderly liquidation of the benchmark.
In the absence of a general legislative solution, the market-led recourse for shutting down EONIA for the many CSAs that are governed by English law or New York law is the fallback protocol of the ISDA 2021 EONIA warranty agreement (the protocol). If both parties to a CSA referring to EONIA adhere to the Protocol, then the CSA will be deemed to be amended to:
- incorporate the new interest rate definitions from the ISDA v 2.0 Guarantee Agreement (the Guarantee Definitions); and
- change EONIA’s references to “EONIA (guarantee rate)”, a term defined in the definitions of guarantees that provides a pullback to € STR + 8.5 basis points when EONIA ceases to be published.
This allows for widespread treatment of EONIA termination in ASCs without the need for individual bilateral negotiations and provides a more robust fall-back solution for the purposes of complying with applicable referral regulations.
Since the protocol’s release last month, there have been relatively few adherents compared to some earlier ISDA protocols impacting the overall market. Despite this, we expect membership numbers to increase significantly over the next few months.
In addition, ISDA has published two model bilateral endorsements that parties can use to update EONIA references in a wider range of derivative documents, including transaction confirmations, warranty documents and agreements- frames. A wider range of modification options are also provided, including fallbacks to fixed € STR as well as € STR plus 8.5 basis points.
EONIA or € STR, what’s the difference?
- EONIA was a measure of day-to-day interbank borrowing costs, usually based on estimates. Prior to October 2019, EONIA was based on submissions from 28 European banks regarding the cost of interbank borrowing. The EONIA reflected the offer rate, which is what banks said they would have to pay to borrow if they contacted another bank to do so.
- The € STR is a measure of overnight borrowing costs in the wholesale market that has been published since October 2019. The € STR is based on transaction data from 52 banks when closing transactions with financial counterparties (rather than just other banks).
Prices tend to be lower in the wholesale market, so an average 8.5 basis point gap was observed before October 2019 between EONIA and a calculation of € STR. This observed spread then became the fixed spread on € STR for the published EONIA.
The EONIA Guarantee Protocol offers market participants an efficient way to modify the terms of certain ISDA Guarantee Agreements to incorporate a pullback to € STR plus 8.5 basis points upon termination of EONIA.