Knowledge Toolkit: Why ESTR is going in effect?

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The Euro Short-Term Rate (ESTR) is an interest rate benchmark that reflects the overnight borrowing costs of banks within the Eurozone. The rate is calculated and published by the ECB and is published on each TARGET2 business day based on transactions conducted and settled on the previous TARGET2 business day.

The ESTR is replacing the previous Euro Overnight Index Average (EONIA) and Euro Interbank Offered Rate (EURIBOR) to become the benchmark for the European Union (EU) and European Free Trade Association (EFTA).

The reason for this is that EURIBOR and EONIA failed to meet the requirements set out in the EU’s new benchmark regulations, which states that all interbank rates must be based on data rather than estimates and surveys.

  • How it works: 
    The ESTR uses the transaction data from the 52 largest eurozone banks, representing the average interest rate attached to loans throughout a business day.
  • ESTR vs. LIBOR: 
    LIBOR is the average of 35 different benchmark interest rates that cover USD, EUR, GBP, JPY, and CHF, and is taken from a survey asking banks at what rate they would borrow money. The rate started to decline in use following the scandal of manipulation in 2012, increasing the necessity for a transaction-based system.
  • Good or bad gearing ratio? 
    There are basic guidelines to identify desirable and undesirable ratios: high gearing ratio (anything above 50%), low gearing ratio (anything below 25%), optimal gearing ratio (anything between 25% and 50%).
  • Pros and cons of ESTR: 
    ESTR is more transparent, based on regulated and secured data. ESTR will include a larger number of parties, leading to more accuracy in the interbank rate. Cons of ESTR: valuation risk. 
    EONIA rates were higher than ESTR, so some contracts might see a difference in the rates they are given.

See Bloomberg’s Guide to the World’s New Benchmarks After Libor…

Deutsch:
IG Bank, UK: A guide to LIBOR  IG Academy an UK  
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