PAPER SETTING OUT THE LEGAL GROUNDS FOR THE PROPOSED REFORMS TO EURIBOR - 12th February 2019 - EMMI
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D0041-2019
PAPER
SETTING OUT THE LEGAL GROUNDS
FOR THE PROPOSED REFORMS TO
EURIBOR
12th February 2019
European Money Markets Institute
56, Avenue des Arts 1000 Brussels | +32 (0) 2 431 52 08 | info@emmi-benchmarks.euPaper setting out the legal grounds for the proposed reforms to EURIBOR
February 2019
The European Money Markets Institute (EMMI, formerly known as EURIBOR-EBF) is an international non-profit making
association under Belgian law founded in 1999 with the launch of the euro and based in Brussels (56, Avenue des Arts, 1000
Brussels.
As per EMMI’s statutes, its purpose is twofold:
I. The development and support of activities related to the money and interbank markets. To that end, the
association shall have the task of making an evaluation of fluctuations in the interest rates in the money and
interbank markets of the euro area and of providing the results of its research to the monetary authorities and
interested parties who are active in these markets.
II. In ancillary, the association shall also serve to support other practical initiatives fostering the integration of the
European financial market such as but not limited to the improvement of the liquidity, safety and transparency of
the European short term debt market by means of a harmonized framework for short-term European paper ‘STEP’.
EMMI currently provides the following two indexes: EURIBOR®, the money market reference rate for the euro and EONIA®,
the effective overnight reference rate for the euro.
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Contents
1 Introduction ....................................................................................................................... 5
2 Legal Grounds for the Reforms to the EURIBOR Methodology .............................................. 7
2.1 Overview of the Reforms ..............................................................................................................7
2.2 First Reform: Evolution towards a hybrid methodology ...............................................................7
2.3 Second Reform: Expanding the Eligible Types of Transactions and Counterparties.....................9
3 Clarifying the EURIBOR specification ................................................................................. 11
4 Conclusion ........................................................................................................................ 12
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1 Introduction
1) Reference rates based on unsecured interbank short-term lending and borrowing were introduced in the
late 1960s and are now dominant in financial systems. They serve as benchmarks, used to measure the
relative performance of investment returns or funding costs, or as reference rates upon which financial
instruments are contracted to establish the terms of agreement. Classes of financial contracts linked to
reference rates include retail loans, syndicated and bilateral corporate loans, OTC financial derivatives—
such as FRAs and long-term swaps—and exchange-traded financial derivatives—such as future contracts
and options on these.
2) With the start of the euro in January 1999, the EURIBOR index was created and replaced domestic reference
rates across the Eurozone. EURIBOR is nowadays a major euro interest reference rate, administered by the
European Money Markets Institute (EMMI). In light of its wide use in the global financial system as a
reference rate for a large volume and broad range of financial products and contracts, in 2016 EURIBOR
was established as a critical benchmark of systemic importance for financial stability by the European
Commission 1.
3) During the financial crisis, cases of market manipulation raised concerns about the appropriateness of the
processes and methodologies used in formulating reference interest rates. As a result, initiatives in a
number of fora were established to analyse how the increasing loss of confidence could be improved,
including the EBA/ESMA Principles for Benchmark Setting Processes in the EU (January 2013), the IOSCO
Principles for Financial Benchmarks (January 2013), the Financial Stability Board (FSB) report Reforming
Major Interest Rate Benchmarks (July 2014).
4) Over the past years EMMI has worked to implement wide-ranging reforms related to its benchmark
administration activities. These reforms were aimed at ensuring EMMI had established and operated a best-
in-class governance, oversight, and control framework in alignment with the ESMA-EBA Principles and the
IOSCO Principles, as well as with Regulation (EU) 2016/1011 of the European Parliament and of the Council
of 8 June 2016 on indices used as benchmarks, which entered into force on 30 June 2016 (BMR). Despite
all the progress made by EMMI in enhancing the transparency and governance of the EURIBOR benchmark,
the current methodology remains based on collecting quotes from contributing banks and the use of expert
judgment.
5) Since the end of 2013, and after performing two large data collection exercises, EMMI worked on the
development of a new determination methodology for EURIBOR solely anchored in transactions. In 2016, a
few months prior its planned implementation, EMMI decided to conduct a six-month long verification
exercise (PLVP), in order to verify the viability of a calculation methodology developed in substantially
different market conditions. The conclusion of the exercise was that in the current environment, the
evolution from the current quote-based to a solely transaction-based methodology via a seamless transition
was not feasible 2.
6) Since then, and on the basis of the PLVP findings, EMMI has been working on the development of a hybrid
methodology for EURIBOR, where the calculation is supported by transactions from Panel Banks whenever
1Commission Implementing Regulation (EU) 2016/1368 of 11 August 2016 establishing a list of critical benchmarks used in financial markets
pursuant to Regulation (EU) 2016/1011 of the European Parliament and of the Council
2 Pre-Live Verification Program Outcome and Way Forward, 4 May 2017, https://www.emmi-benchmarks.eu/assets/files/D0246B-
2017_PLVP%20public%20report%20and%20way%20forward_FINAL.pdf
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available, and relies on other related market pricing sources when necessary. Where the aforementioned
data is absent, the hybrid methodology relies on a Panel Bank’s appreciation of their cost of funds. The
hybrid methodology was developed by EMMI with the support of a dedicated Task Force, in which the
Belgian Financial Services and Markets Authority (FSMA) participated as an observer. The Task Force served
EMMI to gather market participants’ initial feedback and guidance on the new methodology.
7) On 26 March 2018, EMMI published the (First) Consultation Paper on a Hybrid Methodology for EURIBOR,
seeking the market’s views on EMMI’s proposed hybrid methodology for EURIBOR. The feedback received
in response to the consultation questions was supportive of EMMI’s proposal.
8) From May until the end of July 2018, EMMI, with the participation of the majority of EURIBOR panel banks,
tested the proposed hybrid methodology. In October 2018, EMMI published the Second Consultation Paper
on a Hybrid Methodology for EURIBOR. This consultation paper presented a summary of EMMI’s findings
resulting from the Hybrid EURIBOR Testing Phase (HETP), and set out EMMI’s proposals for the different
methodological parameters that still needed to be specified. The feedback received in response to the
consultation questions was again supportive of EMMI’s proposal. During the meeting of the Working Group
on euro risk-free rates on 18 October 2018, the FSMA commended EMMI on the work done to develop and
test the hybrid methodology, saying that it represented a significant step towards a BMR-compliant
EURIBOR 3.
9) Following the analysis of the data and submissions collected as part of the HETP, EMMI is confident that
the hybrid methodology is a robust evolution of the current quote-based methodology. The hybrid
methodology is described in detail in the Blueprint for the Hybrid Methodology for the Determination of
EURIBOR published on 12 February 2019 (the Blueprint). The phased implementation of the methodology
will occur during 2019. EMMI intends to apply for authorization to the Belgian FSMA by Q2 2019.
10) Together with the new methodology, EMMI will also reformulate the EURIBOR specification to remedy
some of the shortcomings EMMI identified in the current EURIBOR specification. The new EURIBOR
specification is also described in the Second Consultation Paper on a Hybrid Methodology for EURIBOR.
11) During the reform process, EMMI has assessed the legal grounds for those proposed reforms on the basis
of advice by Allen & Overy and consultations with the FSMA and various stakeholders to ensure that the
hybrid methodology is compliant with the regulatory requirements of the BMR. This paper sets out EMMI’s
analysis with respect to the compliance of the proposed reforms with the BMR.
12) This paper is based on the following documents and should be read together with those documents: (i) the
Consultative Position Paper on the Evolution of EURIBOR and its annexes published by EMMI on 30 October
2015, (ii) the report on the Pre-Live Verification outcome and the way forward published by EMMI on 4 May
2017, (iii) the (First) Consultation Paper on a Hybrid Methodology for EURIBOR published by EMMI on 26
March 2018, (iv) the summary of the stakeholder feedback on the (First) Consultation Paper published by
EMMI on 28 June 2018, (v) the Second Consultation Paper on a Hybrid Methodology for EURIBOR published
by EMMI on 17 October 2018, (vi) the summary of the stakeholder feedback on the Second Consultation
Paper published by EMMI on 12 February 2019 and (vii) the Blueprint of the Hybrid Methodology.
Capitalised terms not defined in this paper have the meaning set out in the aforementioned documents.
3 Summary of the meeting of the working group on euro risk-free rates held in Frankfurt am Main on Thursday, 18 October 2018, item 4.1, p. 2.
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2 Legal Grounds for the Reforms to the EURIBOR Methodology
2.1 Overview of the Reforms
13) EMMI is reforming the EURIBOR benchmark for multiple reasons:
» to comply with Regulation 2016/1011 of the European Parliament and of the Council of 8 June 2016
on indices used as benchmarks in financial instruments and financial contracts or to measure the
performance of investment funds (BMR), which sets out the legal framework for benchmarks so that
EMMI can apply for authorisation under the BMR by Q2 2019;
» to follow the guidelines of international organisations on the administration of benchmarks such as
the International Organization of Securities Commissions (IOSCO), the Financial Stability Board (FSB),
the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA).
These guidelines include, among others, the IOSCO Principles for Financial Benchmarks (IOSCO
Principles) 4, the EBA/ESMA Principles for Benchmark-Setting Processes in the EU (EBA/ESMA
Principles) and the FSB Market Participants Group’s final report on Reforming Interest Rate
Benchmarks 5; and
» to adapt the EURIBOR methodology to the evolving circumstances in the market (the underlying
interest) that the EURIBOR seeks to measure.
14) The current methodology is quote-based, while the BMR and the guidelines of international organisations
on the administration of benchmarks require benchmarks to be anchored to the extent possible in
transactions. Therefore EMMI intends to implement a new determination methodology for the EURIBOR
benchmark that is, to the extent possible, anchored in transactions.
15) The market (the underlying interest) that the EURIBOR benchmark seeks to measure has evolved as there
has been a steady decline in interbank activity and banks increasingly rely on broader wholesale funding
from a range of transactions with different counterparties in different markets. EMMI wishes to expand the
eligible types of transactions and counterparties in the hybrid methodology to adapt the methodology to
the changing market circumstances.
2.2 First Reform: Evolution towards a hybrid methodology
16) The first reform is replacing the current quote-based methodology with a hybrid methodology that is based
on transactions to the extent possible. The new methodology is described in detail in the Blueprint of the
Hybrid Methodology.
17) The main reason why EMMI intends to reform its calculation methodology is because the Benchmark
Regulation and the guidelines of international organisations on the administration of benchmarks require
that benchmarks are be based on arm's length transactions to the extent possible. The main rationale for
this preference is that benchmarks anchored in transactions are much less likely to be subject to
manipulation.
18) For the first reform, the following articles of the BMR and the following guidelines are relevant:
4This paper mainly cites the IOSCO Principles as these are the most comprehensive and detailed guidelines.
5These are soft law documents, i.e. non-binding recommendations. EMMI believes however that a normal, prudent benchmark administrator
should take these recommendations into account.
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» Article 11.1 (a) of the BMR:
“The input data shall be sufficient to represent accurately and reliably the market or economic reality that
the benchmark is intended to measure.
The input data shall be transaction data, if available and appropriate. If transaction data is not sufficient
or is not appropriate to represent accurately and reliably the market or economic reality that the
benchmark is intended to measure, input data which is not transaction data may be used, including
committed quotes, indicative quotes and estimates;”
» Principle 7 of the IOSCO Principles:
“The data used to construct a Benchmark determination should be sufficient to accurately and reliably
represent the Interest measured by the Benchmark and should: (…)
b) Be anchored by observable transactions entered into at arm’s length between buyers and sellers in the
market for the Interest the Benchmark measures in order for it to function as a credible indicator of prices,
rates, indices or values. (…)
This Principle requires that a Benchmark be based upon (i.e., anchored in) an active market having
observable Bona Fide, Arm’s-Length Transactions. This does not mean that every individual Benchmark
determination must be constructed solely of transaction data.”
» Principle 8 of the IOSCO Principles:
“An Administrator should establish and Publish or Make Available clear guidelines regarding the hierarchy
of data inputs and exercise of Expert Judgment used for the determination of Benchmarks. In general, the
hierarchy of data inputs should include:
a) Where a Benchmark is dependent upon Submissions, the Submitters’ own concluded arms-length
transactions in the underlying interest or related markets;
b) Reported or observed concluded Arm’s-length Transactions in the underlying interest;
c) Reported or observed concluded Arm’s-length Transactions in related markets;
d) Firm (executable) bids and offers; and
e) Other market information or Expert Judgments.”
» Principle B.7 of the EBA/ESMA Principles
“The data used to construct a Benchmark determination should be sufficient to represent accurately and
reliably the underlying assets or prices, interest rates or other values measured by the Benchmark. These
data should be anchored by observable transactions entered into at arm’s length between buyers and
sellers in the market for the underlying assets or prices, interest rates or other values the Benchmark
measures in order for it to function as a credible indicator of prices, rates, indices or values.
Administrators may rely on non-transactional data such as offers and bids and adjustments based on
expert judgment for purposes of constructing an individual Benchmark determination, but such data
should only be used as an adjunct or supplement to transactional data. (…)”
19) In 2016 EMMI conducted a six-month long PLVP exercise to verify the viability of a determination
methodology solely based on transactions. The conclusion from the PLVP exercise was that in the current
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market environment, the evolution from the current quote-based methodology to a methodology that is
solely based on transactions is not feasible.
20) Therefore, EMMI decided to develop a hybrid methodology that that is supported by transactions whenever
available, and relies on other related market pricing sources when no transaction data is available. The
hybrid methodology consists of a hierarchical approach divided in three levels:
1. Level 1 consists of contributions of panels banks based solely on
transactions in the underlying interest at the Defined Tenor from the prior
TARGET day, using a formulaic approach provided by EMMI.
2. Level 2 consists of contributions based on transactions in the underlying
interest across the money market maturity spectrum and from recent
TARGET days, using a defined range of formulaic calculation techniques
provided by EMMI.
3. Level 3 consists of contributions based on transactions in the underlying
interest and/or other data from a range of markets closely related to the
unsecured euro money market, using a combination of modelling
techniques and/or the Panel Bank’s judgment.
21) Both the Level 1 and the Level 2 contributions under the hybrid methodology will solely be based on
transactions. The Level 3 contribution must also be based on transaction data and expert judgment is only
an optional part of the Level 3 methodology. The Level 3 contribution can only be used if it is impossible for
panel banks to make a contribution on the basis of the Level 1 or Level 2 methodology 6.
22) The Hybrid Methodology is thus anchored in transactions to the extent possible and follows the hierarchy
of data inputs set out in IOSCO Principle 8. Therefore, EMMI considers that it meets the requirements of
article 11.1 (a) BMR and follows IOSCO and EBA/ESMA Principles.
2.3 Second Reform: Expanding the Eligible Types of Transactions and Counterparties
23) The second reform relates to the eligible types of transactions and counterparties to determine the rate of
the EURIBOR benchmark. The current methodology and specification refers to interbank transactions which
reflects the structure of the money markets in the 1980s and 1990s when bank-to-bank activity was a
predominant source of bank wholesale funding. The last decade has witnessed a steady decline of interbank
activity. There has been a significant shift in banks’ funding sources as banks have increased their reliance
on broader wholesale financing. This is confirmed by the statistics on the euro money market based on the
data collected under the umbrella of the ECB’s money market statistical reporting (MMSR) regulation 7.
24) With the second reform, EMMI intends to adapt the EURIBOR methodology to the evolving market
circumstances. The eligible types of transactions and counterparties will be expanded to reflect the range
of wholesale funding sources for banks and not only interbank loans.
6 The administrator of the LIBOR benchmark has also adopted a waterfall methodology that is similar to the hybrid methodology that EMMI will
adopt. https://www.theice.com/publicdocs/ICE_LIBOR_Methodology.pdf
7 Data related to activity in the unsecured segment of the euro money market as captured by the ECB as part of the MMSR can be obtained on
the ECB’s website, https://www.ecb.europa.eu/stats/financial_markets_and_interest_rates/money_market/html/index.en.html
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25) For the second reform, the following articles of the Benchmark Regulation and the following guidelines are
relevant:
» Article 11.4 of the Benchmark Regulation:
“Where an administrator considers that the input data does not represent the market or economic reality
that a benchmark is intended to measure, that administrator shall, within a reasonable time period, either
change the input data, the contributors or the methodology in order to ensure that the input data does
represent such market or economic reality, or else cease to provide that benchmark”.
» Article 12.2 of the Benchmark Regulation:
“When developing the benchmark methodology the benchmark administrator shall:
(a) take into account factors including the size and normal liquidity of the market, the transparency of
trading and the positions of market participants, market concentration, market dynamics, and the
adequacy of any sample to represent the market or the economic reality that the benchmark is intended
to measure;”
» Principle 10 of the IOSCO Principles:
“The administrator should periodically review the conditions in the underlying interest that the Benchmark
measures to determine whether the Interest has undergone structural changes that might require changes
to the design of the Methodology”.
» Principle 6 of the IOSCO Principles:
“Benchmark design should take into account the following generic non-exclusive features, and other
factors should be considered, as appropriate to the particular Interest:
a) Adequacy of the sample used to represent the Interest;
b) Size and liquidity of the relevant market (for example whether there is sufficient trading to
provide observable, transparent pricing);
c) Relative size of the underlying market in relation to the volume of trading in the market that
references the Benchmark;
d) The distribution of trading among Market Participants (market concentration);
e) Market dynamics (e.g., to ensure that the Benchmark reflects changes to the assets underpinning
a Benchmark).”
» Principle B.6 of the EBA/ESMA Principles
“Benchmark Administrator should regularly review the Benchmarks or the range of Benchmarks provided
(such as, for example, asset classes, currencies and tenors). It should ensure that any Benchmark reflects
the market or interest it seeks to represent.”
26) It is clear from article 11.4 of the Benchmark Regulation, Principle 10 of the IOSCO Principles and Principle
B.6 of the EBA/ESMA Principles that benchmark administrators such as EMMI should periodically review
whether the market their benchmark intends to measure (the underlying interest) has undergone changes
that require changes to the methodology used to determine the benchmark. Article 12.2 of the Benchmark
Regulation and Principle 6 of the IOSCO Principles also explicitly provide that the distribution of trading
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among market participants (market concentration) and the market dynamics need to be taken into account
in the benchmark design.
27) EMMI is thus under an obligation to adapt its benchmarks to the changing market circumstances. By
expanding the counterparties and the instruments, EMMI is adapting the EURIBOR methodology to the
changes in banks’ funding sources. The second reform is implemented to meet EMMI's obligation to
adapting the EURIBOR methodology to the changing market circumstances.
3 Clarifying the EURIBOR specification
28) The current specification of the EURIBOR benchmark as set out in the EURIBOR Code of Conduct reads:
“EURIBOR® is the rate at which euro interbank term deposits are being offered within the EU and EFTA
countries by one prime bank to another at 11.00 a.m. Brussels time..”
29) This specification does not distinguish between the underlying interest and the determination
methodology. The underlying interest is the economic variable (the market) that a benchmark seeks to
measure. The determination methodology is the means to practically measure the underlying interest. The
current specification contains elements of the current methodology, which will be reformed as set out
above. Therefore, EMMI wishes to clarify the EURIBOR specification and remove the elements that refer to
the current quote-based methodology.
30) As noted in the Consultative Position Paper on the Evolution of EURIBOR, the family of -IBOR benchmarks
are based upon and aimed at representing the cost of funds for banks 8. In other words, the EURIBOR
benchmark has always sought to measure banks’ costs of borrowing wholesale funds in unsecured money
markets. Therefore, EMMI will define the underlying interest for EURIBOR as:
“the rate at which wholesale funds in euro could be obtained by credit institutions in the EU and EFTA
countries in the unsecured money market”
A credit institution is defined as:
“an undertaking the business of which is to take deposits or other repayable funds from the public and to
grant credits for its own account”. 9
31) The underlying interest of the EURIBOR benchmark is a borrowing rate. By referring to “deposits (…) being
offered (…) by one prime bank to another”, the current specification does not make it fully clear that the
underlying interest is the rate at which the second prime bank could borrow the funds offered by the first
prime bank. The definition of underlying interest remedies this by emphasising that EURIBOR is the rate at
which funds could be obtained by credit institutions.
32) The reference to “interbank term deposits” in the current EURIBOR specification is a methodological
consideration, and not part of the underlying interest. At the time the EURIBOR benchmark’s was created,
interbank transactions were the predominant source of banks’ wholesale funding, which explains the
reference to these transactions. As explained above, there has been a significant shift in banks’ funding
sources as interbank activity has declined and banks have increased their reliance on other types of
8 See International Monetary Fund, What Is LIBOR? http://www.imf.org/external/pubs/ft/fandd/2012/12/basics.htm; IOSCO, Review of the
Implementation of IOSCO’s Principles for Financial Benchmarks by Administrators of EURIBOR, LIBOR and TIBOR, p. 64, http://www.fsb.org/wp-
content/uploads/r_140722a.pdf.
9 Credit institutions have the meaning set out in Article 4(1)(1) of Regulation (EU) No. 575/2013,
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wholesale financing. The underlying interest of the EURIBOR benchmark is to represent the bank’s own cost
of funds in unsecured money markets, and not to just measure the rate for interbank activity. The new
specification will make this clear by explicitly stating that the underlying interest of the EURIBOR benchmark
relates to wholesale funds.
33) The concept “prime bank” in the current EURIBOR specification is also a methodological consideration, and
not part of the underlying interest. This concept is related to the current methodology where the prime
bank is the party who supplies the funds to the panel banks, which reflects the structure of the money
markets in the 1980s and 1990s when interbank borrowing was the predominant source of wholesale funds
for banks. As part of the new hybrid methodology, the eligible types of transactions and counterparties to
determine the rate of the EURIBOR benchmark will be extended to take into account the evolving market
circumstances. The concept will thus be removed as the new methodology takes into account a broader
range of counterparties.
34) The current specification refers to the rate “at 11.00 a.m. Brussels” which is also the publication date of the
EURIBOR benchmark. This part of the specification will not be retained as a result of the new hybrid
methodology. Under the current quote-based methodology, panel banks must transmit their quotes for
interbank loans offered at 11:00 a.m. C.E.T. The hybrid methodology is based on transactions to the extent
possible and in order to guarantee data sufficiency, the collection of transactions to support EURIBOR’s
determination cannot be limited to those transactions executed near the publication time at 11:00 a.m.
C.E.T. as this would limit the number of transactions and thus the representativeness of the EURIBOR
benchmark. The collection of data over a longer period of time should lead to an increase in the number of
available transactions, providing a more representative measure of EURIBOR’s underlying interest. Given
that the publication of the EURIBOR benchmark will still occur at 11:00 a.m. and to ensure the quality of
the data contributed by Panel Banks, data reflecting transactions executed on day T will be considered as
input for the EURIBOR benchmark published on day T+1. In this manner, apart from guaranteeing that EMMI
captures all Panel Banks’ unsecured money market activity, contributors and EMMI will have enough time
to perform all necessary checks and controls on the submitted and received data, respectively
4 Conclusion
35) EMMI is convinced that the substantive reforms to evolve towards a hybrid methodology based on
transactions to the extent possible and to adapt the methodology to changing market circumstances, find
strong legal support in the Benchmark Regulation and the abovementioned recommendations as set out in
section 2. As part of the reform process, EMMI has consulted with stakeholders on the proposed reforms
and found broad support for the proposed reforms.
36) EMMI will also reformulate the EURIBOR specification to clarify the underlying interest and to remove the
references to the current methodology. The EURIBOR benchmark has always sought to measure banks’
costs of borrowing wholesale funds in unsecured money markets so no substantive changes are made to
the underlying interest of the EURIBOR benchmark.
37) EMMI intends to apply for authorisation under the BMR to the Belgian FSMA by Q2 2019. The FSMA will
also review the compliance of the new EURIBOR methodology with the BMR as part of the authorisation
process.
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38) In view of the foregoing, EMMI is confident that the hybrid methodology is a robust evolution of the current
quote-based methodology and that the hybrid methodology is compliant with the regulatory requirements
of the BMR.
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