On July 3, 2019, the European Central Bank (ECB), acting in its role at the helm of the Banking Union's Single Supervisory Mechanism (SSM), sent a letter to CEOs1 of all Banking Union Supervised Institutions (BUSIs) that are categorized as significant credit institutions (SCIs), and thus directly ECB-SSM supervised, regarding the ongoing benchmark reforms and the transition from, say, the euro overnight index average (EONIA) to the new euro short-term rate (formerly known as ESTER and now known officially as €STR2). This Client Alert3 assesses the requirements set in the letter and the next steps not just for SCIs but also for those existing or new BUSIs that are, as lesser significant institutions (LSIs), subject to indirect ECB-SSM and direct national competent authority supervision. Recipient SCIs are required to respond by close of business (which one would read, conservatively, to be 17h00 Frankfurt time) on July 31. 

Sharper supervisory tone and pressure on transition path

While the ECB-SSM does often send letters setting supervisory expectations and/or requests to banks4, the July 3 letter is phrased as a "Dear CEO" letter.  One might assume this reflects a new tone set by Andrea Enria, Chair of the Supervisory Board, who has spent the past couple of years leading the EBA out of its then London-based offices, but the real point for recipients to note is that this letter is very prescriptive on how, what and by when ECB-SSM supervisory expectations must be met.

The ECB-SSM requires that SCI's senior managers and boards understand the risks associated with global benchmark reforms, notably in respect of the move from EONIA to €ESTR, but also ultimately the EU's Benchmark Regulation (BMR) and its year-end 2021 deadline for the transition to alternative "risk-free rates" or, where permitted, relevant reformed benchmark rates. The letter also states that the ECB "is committed to launching €STR on 2 October 2019". This, along with the other requirements that recipients are expected to comply with in relation to EU BMR compliance, as well as in other thematic areas under the supervision of the ECB-SSM, does not leave much time. 

Specifically, the letter points to the reform of EURIBOR towards a hybrid methodology and the ECB's Working Group on Euro Risk-Free Rates, specifically the recommended "Transition Path" from EONIA to €STER5, including, from October 2, 2019, the shift to EONIA being calculated as EONIA plus a fixed spread of 8.5 basis points6 ahead of EONIA's discontinuation by the end of 2022. These goalposts could move between 2019 and 2021, specifically for both:  

  • the setting of the fixed spread; and/or 
  • the very approach in the Transition Path, a document which itself needs to be read in conjunction with the final outcome of the EONIA to €STR Legal Action Plan7, which is subject to finalization post the Working Group meeting on July 4, 2019. 

Faced with the above, all BUSIs, and not just SCI firms, will need to step up their preparatory action plans or at least their gathering of evidence to provide to the ECB-SSM, so that their planning is sufficiently encompassing, robust as well as agile. Some of this includes internal measures as well as external measures, including collection of consent from various counterparties, where required, to change both the calculation, plus also the publication, as to the input into the rate as well as ultimately what that might mean for a host of products and transactions that use that rate. The ECB-SSM is quite clear in its letter that it will want to see action to make required changes "...for example via bilateral agreements or via master agreements".  This applies both to the EONIA to €STR transition as well as to the changes introduced to EURIBOR and/or for any relevant benchmark in any currency for contracts the SIFIs may be holding.

What do recipient SCIs need to do by July 31, September 15 and before October 2, 2019?

With the main European summer holidays taking place between July 31 (the deadline to deliver evidence in response to the July letter) and the €STR go-live date on October 2, SCIs ought to work with their professional advisers to optimize workflows across all relevant affected product lines that they (or their affiliates) operate in affected by the BMR generally and this Dear CEO letter more specifically. No real industry-wide action group, − beyond some of the work by ISDA and/or the relevant ECB working group − is currently advancing things, or doing so to the timetable of the ECB-SSM, hence the reason why the ECB-SSM requires a supervisory readiness stock take by July 31 as well as: 

  1. a board-approved summary of the SCI's assessment of key risks relating to the benchmark reform and a firm-specific "action plan" to:
    1. mitigate such risks;
    2. address pricing issues, e.g. the alignment of front offices and risk management systems and parallel pricing in both EONIA and €STER; 
    3. implement process changes (which will require governance and control function approvals – including potential model risk management changes8) to facilitate changes in modelling set-up or potential unavailability of historical data for back-testing, validation or calibration in pricing changes. Firms will recall that the ECB-SSM has extended its powers and perimeter in this area, notably through its rules on on-site inspections9 as well as its own views or more formal assessments which have pointed to specific areas where BUSIs need to improve on internal model governance10;
  2. for firms to appoint and notify contact points – at management level – who are in charge of overseeing the implementation of these action plans. This requirement, which is not uncommon, aims to ensure that SCIs to take ownership but also through to management level.

These requirements come ahead of the European summer, where it may be difficult to get the necessary momentum from all required stakeholders within firms.  This goes for not only the delivery of a comprehensive "action plan" for the ECB-SSM, but also for the questionnaire the SCIs are required to submit, by September 15, 2019, setting out quantitative and qualitative fields on the level, and specifically the "significance", of the impact of making the measures in the action plan operational. The ECB-SSM will have its own views on what is deemed to be "significant". 

Even though the goalposts are still possibly subject to further tweaks, notably in relation to the Legal Action Plan, the timing of all this is beyond tight and requires close cooperation of stakeholders right across affected firms. For those BUSIs that are not (yet) within the scope of the reforms – and that could change − or firms that are in the EU but not the Banking Union, they are likely to be affected both by the SCI's that  action plans sent to the ECB-SSM, but also by those firms putting those plans into play.

In summary, stakeholders should not lose sight of how the supervisors are approaching this, namely that the EU's BMR applies EU-wide. So too do the changes to EURIBOR and EONIA as well as a host of other benchmark rates, in any currency, that are highlighted in this letter.  It is conceivable that the ECB-SSM will take an interest in BMR-readiness not just in relation to euro related rates and to ensure that those arrangements are not subject to any lesser compliance and/or governance arrangements. 

As in the past, it should be noted that the ECB-SSM is very (rapidly) capable of using its power as well as ensuring supervisory convergence. This is true of how it will aim to apply the rules or set its supervisory expectations, often taking a concentric approach so that an obligation applies first to SCIs, and then it is , together with the National Competent Authorities (NCAs) that these are "rolled out in the national requirements applicable to relevant BUSIs as well as to NCAs in certain Member States to "mirror" the ECB-SSM rules.


1 Available here.

2 The fact that many keyboards may not have the € symbol has led to a lackluster take-up of €STR when compared to the previous name ESTER (which is perhaps more workable and is unlikely to be confused with either the chemical compound or a character in the Old Testament) or its original working title EUOIR (pronounced EYORE as in the character in A.A. Milne's Winnie the Pooh books).

3 Which possibly ought to be read in conjunction with materials provided at our Eurozone Hub's April 11, 2019 "Replacing IBORs: Roundtable Frankfurt" available here.

4 Available here.

5 Available here.

6 Available here.

7 Available here.

8 See standalone coverage from our Eurozone Hub on this.

9 See our coverage available here.

10 See our coverage available here.

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