10 Nov 2020

Eurex Clearing

EurexOTC Clear consultation - transition plan for transactions referencing the EONIA benchmark

Eurex Clearing Circular 097/20 EurexOTC Clear consultation - transition plan for transactions referencing the EONIA benchmark

1. Introduction

In September 2018, the ECB-organised private sector working group on euro risk-free rates (EUR RfR WG) recommended that the euro short-term rate (€STR) replace the euro overnight index average (EONIA) as the new euro risk-free rate. The €STR rate was first published on 2 October 2019 by the ECB and EONIA’s methodology was at the same time recalibrated as €STR plus a fixed spread of 8.5 basis points. As of this day, EONIA and €STR represent economically equivalent benchmarks.

Following the recommendations from the EUR RfR WG, a major milestone achieved by Eurex Clearing was the adoption of €STR for discounting EUR-denominated cleared-derivatives on 27 July 2020. This limits Eurex Clearing’s main usage of the EONIA benchmark to the clearing of EONIA overnight index swaps and EONIA-EURIBOR basis swaps.

Furthermore, the European Money Markets Institute has announced in 2019 in its EONIA Benchmark Statement that it will discontinue publishing EONIA on Monday, 3 January 2022, as recommended by the EUR RfR WG.

With this circular, Eurex Clearing invites its Members and their clients to provide feedback on the proposed treatment of references to EONIA in outstanding cleared OTC derivatives. The consulted treatment is in line with the EUR RfR WG recommendation to actively transition products referencing EONIA to ESTR before the end of 2021 (see EUR RfR WG’s “Report by the working group on euro risk-free rates - on the impact of the transition from EONIA to the €STR on cash and derivatives products”, recommendation 5). Details of the proposal remain subject to change and future announcements by Eurex Clearing.

2. Required action

Clearing participants are requested to review this circular and, if impacted, to respond to this consultation regarding Eurex Clearing's transition plans for outstanding EONIA linked trades by Monday, 30 November 2020 using the electronic form under the following link:

Consultation > Eurex Clearing's transition plans for outstanding EONIA contracts

We strongly encourage to respond including your contact details in case of further questions.

Overall, the transition from EONIA to €STR might have an impact on clearing participants’ internal processes and positions. Therefore, it might be necessary for clearing participants to update their internal processes and technical interfaces to take these proposed changes into account.

3. Details of the consultation

There are multiple routes to implement the EUR RfR WG recommendation and to avoid adverse effects resulting from the EONIA cessation event on 3 January 2022. The four main routes can be summarised as follows:

1)   Permanent Fallback – permanent reliance on “€STR + 8.5 basis points” as the contractual fallback for EONIA for all outstanding EUR-EONIA-OIS-COMPOUND floating rate references after the EONIA cessation event has occurred. The fallback serves as a permanent mechanism until all trades with a reference to EONIA have matured. No form of compensation is triggered as EONIA and its fallback represent equivalent concepts. This approach is already reflected in the Clearing Conditions of Eurex Clearing AG.

2)   Single-Step Conversion with Cash Compensation – active conversion of all explicit EUR-EONIA-OIS-COMPOUND floating rate references originating from trades maturing after the EONIA cessation event to EUR-EuroSTR-COMPOUND. Any simple spread above the floating rate reference or fixed rates defined in affected trade confirmations would remain unchanged (only the index changes from EONIA to €STR-flat).

A one-off cash compensation would be introduced to mitigate the associated change in present values of affected trades (i.e. the same mechanism utilised during the discounting transition on 27 July 2020 would be used). The conversion is mandatory and affects all cleared EONIA trade references outstanding on the Conversion Date (see below).

3)   Single-Step Conversion with Cash Compensation + Spread Adjustment – the same conversion as outlined above under 2), but with an additional adjustment of the simple spread applied to €STR. Each EONIA floating rate reference is replaced by €STR + simple spread of 8.5 bp (+ any spreads previously existing on EONIA trade references). A one-off cash compensation between counterparties is enforced to mitigate residual changes of the present value.

4)   Single-Step Conversion with Cash Compensation + Fixed-Rate Adjustment - the same conversion as outlined above under 2), but with an additional adjustment of the fixed-rate in OIS and the simple spread applied to €STR in basis swaps. Each OIS fixed-rate is reduced by 8.5 bp and each EONIA floating rate reference in basis swaps is replaced by €STR + simple spread of 8.5 bp (+ any spreads previously existing on EONIA trade references). A one-off cash compensation between counterparties is enforced to mitigate residual changes of the present value.

Eurex Clearing determines that other alternatives which are combinations or variations of the above (such as multi-step approaches of fallback and subsequent conversion) do not offer additional benefits. Further technical details and impacted processes will be shared at a later point in the process.

The Conversion Date is the date for routes 2)-4) on which Eurex Clearing will execute the process to change all outstanding references from EUR-EONIA-OIS-COMPOUND to EUR-EuroSTR-COMPOUND. Upon completion of the conversion, EONIA floating-rate references are no longer eligible in the EurexOTC Clear service.

Consultation matter - proposed transition plan for Eurex Clearing

Eurex Clearing’s proposed transition route is to perform a “Single-Step Conversion with Cash Compensation” as outlined under number 2) above.

Following Eurex Clearing’s preliminary release plan for 2021, the conversion would commence on Friday, 19 November 2021, and would be completed across the weekend of 20-21 November 2021.

Eurex Clearing hereby invites all participants to submit feedback on the proposed until Monday, 30 November 2020 using the electronic form under the following link:

Consultation > Eurex Clearing's transition plans for outstanding EONIA contracts

We strongly encourage to respond including your contact details in case of further questions.

Outline of potentially affected areas

The potential implications are not intended to be complete and might vary across institutions.

Routes

Advantages

Disadvantages

1) 
Permanent Fallback

  • EONIA fallback simple to integrate in the systems
  • Contracts legally undisturbed, as approach is already reflected in the Clearing Conditions
  • No impact on RfR delta and initial margins expected.
  • Trades referencing EONIA cannot be netted with trades referencing €STR due to the spread-inclusive compounding of EONIA floating rates 
  • Trades referencing EONIA potentially problematic in a post-default auction process due to lack of fungibility/liquidity
  • Maintaining references to ceased legacy benchmarks for an extended period.

2)
Single-Step Conversion with Cash Compensation

  • Transition to €STR will be fully completed upon conversion (no legacy references remain)
  • Results in simple OIS (legs)
  • Simplifies risk management
  • Experience with simple cash compensation process established (cf. discounting switch)
  • Approach preferred in the EUR RfR WG recommendation.
  • Operationally more demanding than a Permanent Fallback
  • Legal conversion of cleared trades necessary.
  • RfR delta and consequently initial margins expected to slightly change.

3) and 4)
Single-Step Conversion with Cash Compensation + Spread/Fixed-Rate Adjustment

  • Transition to €STR will be fully completed upon conversion (no legacy references remain)
  • Simplifies risk management
  • Experience with simple cash compensation process established (cf. discounting switch)
  • Only minor impact on RfR delta and initial margins expected.
  • Operationally very demanding
  • Legal conversion of cleared trades necessary
  • Technical support for spread on overnight index swap leg required
  • Spread can be hindrance in netting
  • Potential impact on hedge accounting.

Unless the context requires otherwise, terms used and not otherwise defined in this circular shall have the meaning ascribed to them in the Clearing Conditions or FCM Clearing Conditions of Eurex Clearing AG, as applicable. For the avoidance of doubt, this circular shall not initiate a Consultation as defined in Chapter I Part 1 Number 17.3.1 of the Clearing Conditions.


Further information

Recipients:

All Clearing Members, FCM Clearing Members, Basic Clearing Members, Disclosed Direct Clients and FCM Clients  of Eurex Clearing AG and vendors

Target groups:

Front Office/Trading, Middle + Back Office, IT/System Administration, Auditing/Security Coordination

Contact:

client.services@eurexclearing.com

Web:

www.eurex.com/ec-en/

Authorised by:

Dmitrij Senko