- On Tuesday May 11th the Working Group on Euro Risk-Free Rates published its recommendations on EURIBOR fallback trigger events and on €STR-based EURIBOR fallback rates:
- Contracts and financial instruments referencing EURIBOR should include provisions covering trigger events related to permanent cessation, temporary non-availability and non-representativeness (pre-cessation);
- The working group’s recommendations for an appropriate EURIBOR fallback rate for specific use cases will be based on: (a) a €STR-based term structure methodology for each financial product assessed against a list of key selection criteria; and (b) a spread adjustment methodology used to avoid potential value transfer if a fallback is triggered. In addition, the working group will provide recommendations for the market conventions which could be used to calculate the compounded term rate based on the €STR. The working group recommended both forward-looking, backward-looking and hybrid calculation methodologies in corporate lending, consumer and SME products.
- On Tuesday May 11th the second event of the Series “The SOFR Symposium: The final year” by the ARRC took place . I summarized the topics discussed as follows. Financial markets depend on robust alternative reference rates. Both overnight and forward-looking rates must be built to last. Market participants must remain determined to deploy the highest standards. Alternatives must only be deployed carefully. Term rates are crucial for the acceptance of alternative reference rates, the lack of which may tempt market participants to consider alternatives to the ones chosen by the central banks and working groups. Borrowers observe a lack of products offered by banks. Secondly they are at a knowledge disadvantage to their bankers. They are hardly informed by their bankers. Borrowers lack the systems to work with alternative reference rates, which hampers their use of such products. They call for action to be on the same junction with other market participants. (A full note is available upon request).
- On Tuesday May 11th Mr. Klaas Knot, President of the Dutch Central Bank (DNB) spoke at the International Symposium of the National Association for Business Economics. He addressed systemic risks and how to address vulnerabilities:
- Banks must manage a healthy asset liability mismatch;
- Market participants must be aware that imbalances or shocks can affect the financial system quickly via interconnectedness.
- Market participants must be aware of the intertemporal nature of financial contracts.
Since 2008, efforts to reform the financial system have become international. The first major test of international policy implementation was the Covid-19 crisis, which could be executed with the help of banks that benefited from stronger balance sheets. A second test was the market turmoil of March 2020. Fortunately CCPs were prepared to deploy margining and central clearing better than ever before. I briefly refer to the note about the March 2020 market turmoil by the FSB to stress how important robust and liquid reference rates are: Investors had taken leveraged positions to arbitrage between derivatives and their underlying cash instruments that they reference. The turmoil led to a brief decoupling of US Treasuries versus futures, leading to margin calls in spot markets. Unwinding of these trades likely contributed to illiquidity in bond markets. These events raised awareness about the risks non-bank financial market participants bring to the financial system, a subject to be addressed by the FSB in July 2021. On Thursday May 13th the FCA and the Bank of England supported and encouraged market users and liquidity providers in a statement to switch to SONIA from sterling LIBOR in the sterling exchange traded derivatives markets from June 17th onward. From June 17th on SONIA would be the default reference rate for such products.