ECB to introduce a new reference lending rate

On 12 January 2018, the deadline passed for comments by market participants and third parties on the proposal by the European Central Bank (ECB) to introduce a new euro unsecured overnight interest rate.

This public consultation, launched on 21 September 2017, is the first step in the ECB’s plan to implement the rate before 2020.

Devised by a working group made up of the ECB, Financial Services and Markets Authority, European Securities and Markets Authority, and the European Commission, the plan’s ultimate goal is to identify and adopt a risk-free overnight reference rate for the euro area. The mandate of the working group is to find the best approach for a transition to the rate while ensuring minimal turbulence within the financial markets as a result of the change.

Key facts about the rate include:

• the ECB intends to introduce it as a benchmark for existing private-sector rates (eg Euribor, Eonia, etc.);
• it will be developed according to the standards set by the International Organization of Securities Commissions;
• the potential uncertainty that will result in case of absence of a "reliable private benchmark" and its long-lasting impact on the financial system are the main reasons for the initiative;
• the rate will be based on statistical information collected by the ECB through the MMSR Regulation.

Despite the work accomplished so far, the ECB's main hurdle in introducing the rate may be a lack of interbank activity in the EU overnight unsecured market.

The ECB has acknowledged that volumes in the unsecured market are low, but that unsecured money market activity remains concentrated in the "overnight segment." This fact will most certainly be considered in the responses to the public consultation, which the ECB will report on in a published summary.

All of this represents big news for banks, investors, and other market participants. According to the ECB, interest rate benchmarks are currently in the process of “in-depth reform,” and it undertook this initiative because of the crucial “anchoring role” benchmark rates play in the financial markets, not to mention their importance in transmitting ECB monetary policy.

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