On 24 April 2019, the Netherlands Authority for Financial Markets (AFM) and the Netherlands Central Bank (DNB) issued a joint letter to Dutch institutional investors, including banks, insurers and pension funds, about the ongoing worldwide benchmark rate reforms. They ask investors to analyze the risks that this transition will present, including operational, legal, valuation and hedging risks. The benchmark reforms will most directly affect investors using financial instruments which reference the benchmark rates. Interest rate swaps and other interest rate derivatives are key examples but loans, securities and deposits with variable interest payments may also be impacted.
Following the Libor scandal, which emerged in 2012, authorities across the world have put plans in place to reform the most important benchmark interest rates. These reforms have focused on making benchmark rates more reliable and less susceptible to manipulation. In markets where Libor, the London Inter-Bank Offered Rate, was the main benchmark, authorities have looked to find suitable replacements. In the eurozone, authorities propose to replace Eonia, the Euro Over-night Index Average, with a new reference rate and to reform Euribor.
The letter calls for investors to prepare for the planned changes and to contribute to the process of moving to alternative rates where they can. As part of this process, AFM and DNB have requested investors answer a series of questions covering their exposure to the benchmark rates and their preparations. For investors who have received the letter, responses are sought by 17 June 2019.
The Euro Short-Term Rate (ESTER), the planned replacement for Eonia, is due to go live in October 2019. Eonia is widely used for the valuation of interest rate swaps and the calculation of collateral requirements. Since Eonia rates remain higher than the "pre-ESTER" rates which the ECB has been publishing in preparation for ESTER, a valuation difference would be expected unless adjustments are made. There is also the potential for the Euribor reforms to have an impact as most interest rate swap contracts currently reference Euribor for their variable payments.
As the benchmark reforms develop, we will continue to monitor what is happening and the potential impact it may have on portfolios.