EURIBOR: the worst has been avoided, though much remains to be done
Two crucial steps for orderly implementation of a new EURIBOR benchmark compliant with the European Benchmarks Regulation (BMR) have just taken place. One is the authorization of EURIBOR administrator EMMI, and the other, the recent publication of the official statement describing the methodology and other technical specifications for the benchmark. These milestones are very important, but there continue to be legal risks and everyone would be well advised to pay more attention than ever before to how things unfold in the coming months.
EMMI has been providing the current euribor rate over recent years, though on the basis of a methodology that will not be compliant with the BMR; the transitional period in which financial institutions are allowed to use the current benchmark ends on December 31, 2019 (although there has been a political agreement to extend it for a further two years). EMMI has therefore been working on an alternative “hybrid” methodology, which has now been published with the goal of having it ready before the end of 2019, to strive to make the transition process as non-disruptive as possible.
Reform and transition
The authorization and registration of EMMI as administrator of the benchmark and EMMI’s publication of the official statement describing the new characteristics of the benchmark have laid the foundations for the proper functioning of the future EURIBOR. But the new benchmark is not yet ready to be brought into operation and unfinished tasks need to be completed before the new methodology can be implemented and the reformed benchmark can start to be published by the end of the year. The current EURIBOR now being published is not the fully reformed benchmark and it is slated to disappear.
The implications that the disappearance or mutation of a benchmark as widely used as EURIBOR could have are manifold and very major in a wide range of areas from parties’ rights and obligations related to contracts and financial instruments to accounting for balance sheet items or the calculation models for credit institutions’ capital requirements. The strategy followed for EURIBOR has been designed to avoid its disappearance or complete replacement with a new benchmark and achieve a smooth transition to its reform, so as to mitigate all possible impacts.
Don't forget to read the small print
From the standpoint of contractual legal matters the difference between (i) disappearance and replacement and (ii) reform and adaption could be huge. Existing contracts and instruments may specify the former EURIBOR, but they may also make provision for adaptation to a reformed benchmark that is sufficiently similar, to avoid a gap in the contract. Something positive and important about the new benchmark is that its name and its administrator have not changed, and especially that the underlying market or economic reality that EURIBOR measures will continue to be the cost of wholesale funding of credit institutions in the unsecured euro money market. EMMI's statement has already provided a basis for the process as involving an evolution of the same benchmark not the creation of a different one.
It cannot be taken for granted, however, that all contracts and instruments will withstand the reform without any incidents. Every clause will have to be examined in the light of the circumstances that will actually happen. Mainly because the reform does not appear to be accompanied by any legislation making it mandatory for every reference to EURIBOR to be construed to mean the benchmark resulting from the reform.
Not everything is in place
Although the described steps are important, the implementation process remains unfinished and we must keep a close eye on it. In this vein, the ECB has warned institutions not to rely on anything being in place in relation to EURIBOR: its final assessment is not expected until the end of the year and a working group is in the process of identifying and recommending fallback rates for EURIBOR in the event of a material change or cessation; still more importantly, the ECB has warned that the long-term future of EURIBOR depends on the availability of enough panel banks to support it. By mentioning this it has pinpointed a possible vulnerability.
ECB also included a reminder about the future of the other euro rate, EONIA. This rate will indeed disappear at the beginning of 2022 to be replaced by €STR, the new overnight rate that the ECB itself will launch and administer in October 2019, in a process potentially geared more towards requiring renegotiations of contracts and operational adaptations in view of the differences between both rates.
LIBOR: a much more intricate story
While the futures of EONIA and EURIBOR continue to require the greatest attention and prudence, LIBOR’s outlook is even more challenging: LIBOR, the family of rates measuring the cost of global banks’ funding in pounds sterling, dollars and other currencies, does appear set to disappear in 2021. The new possible alternative rates, SOFR and SONIA, are quite different because they only relate to secured overnight transactions. Here, adaptation and renegotiation efforts will be substantial. Aware of the threats to borrowing and positions in these currencies, the SEC in the U.S. recently published a statement stressing the seriousness and urgency of the matter and the many measures that must be adopted by every institution under its supervision.
A large number of Spanish and European institutions also have contracts and instruments linked to LIBOR and they too must move on with their preparations.
Rafael González-Gallarza and Gonzalo García-Fuertes, partners at Garrigues Corporate Department.