Stable capital markets and the risk of the IBOR transition
The IBOR transition in 90 seconds
Interbank Offered Rates (IBORs) play an important part in a properly functioning financial system. IBORs are a series of reference interest rates based on rates that the banks charge each other for credit transactions. These reference interest rates are widely used in financial contracts such as business loans, derivatives and sometimes also mortgages.
In the past, these reference interest rates were subject to manipulation. The potential seriousness of this was made clear by the LIBOR scandal (2012), which led to a worldwide loss of confidence in reference interest rates and seriously damaged the integrity of the global financial markets. So it is time for improved and new reference interest rates.
New rules have also been introduced with which European reference interest rates have to comply on 1 January 2022 under the EU Benchmark Regulation. The main thing now is to be well prepared.
The main European reference interest rates are EONIA and EURIBOR. Partly because of its large pensions sector, the Netherlands has a large market for interest-rate derivatives that are based on EONIA or EURIBOR.
EURIBOR is currently being reformed and will use a new calculation method in order to comply with the new requirements.
EONIA will no longer be available after 1 January 2022. Financial institutions will therefore have to move to a new reference interest rate that will be issued by the European Central Bank: the Euro Short-Term Rate, or €STR. EONIA has already been linked to €STR since 2 October 2019, so progress is being made.
But if the transition does not happen quickly enough, a reference interest rate disappears or bank systems and contracts are not amended properly or on time, then there will be a big problem..
How serious is the problem?
We see various financial, operational and legal risks. And given the value involved in contracts based on the various reference interest rates – and the systems and models that are constructed on this basis – a problematic transition could lead to systemic risks. It is not impossible that lack of clarity regarding the correct reference interest rate will lead to liquidity risk that could subject financial markets to temporary pressure.
So there is work to do to ensure the stability of the financial system. Financial institutions need to engage in good and timely preparation. Given the scale of use of reference interest rates, we consider it important to stress that customers must be informed in good time and contracts must be amended in a fair and transparent manner.