European Central Bank goes out in search of new benchmark interest rate

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The European Central Bank is based in Frankfurt (Source: Getty)

The European Central Bank (ECB) today said it would develop a new overnight reference interest rate by 2020, which could mean the creation of a new benchmark for risk-free rate used in billions of dollars of contracts.

Confidence in existing benchmarks, such as the Euro Interbank Offered Rate (Euribor) and the Euro Overnight Index Average (Eonia), has dwindled in recent years in part thanks to rate-rigging scandals.

It comes after the UK’s Financial Conduct Authority (FCA) announced in July that it would be seeking to drop London interbank offered rate (Libor) by 2021.

The European Commission has estimated that Euribor underpins contracts, mostly interest rate swaps, with a nominal value of €180 trillion (£159 trillion).

The ECB today noted that Euribor and Eonia, the two most widely used Euro benchmarks, are “based on the unsecured interbank market”.

“Both benchmarks rely on the voluntary contributions of two distinct panels of banks, the number of which has fallen sharply in recent years,” the bank said.

The ECB, which could strengthen the existing benchmarks or replace them, said today that the “high-level features of this new overnight interest rate will be communicated to market participants” at some point next year.

The ECB also today said it was launching a new working group alongside the European Commission, Financial Services and Markets Authority (FSMA) and the European Securities and Markets Authority (ESMA) to identify and adopt a “risk-free overnight rate”.

“Once it has made a recommendation on its preferred alternative risk-free rate, the group will also explore possible approaches for ensuring a smooth transition to this rate, if needed in the future,” the ECB said.

“For such a case, careful transition planning by market participants aims to minimise disruption to markets and consumers and to safeguard the continuity of contracts to the greatest extent possible, including contracts that currently reference a term rate rather than an overnight rate.

“These tasks require the involvement of public authorities and a concerted effort by all market participants to facilitate a gradual reduction of the current reliance on the IBORs.”

Read more: Six traders plead not guilty to Euribor rigging