Clarus Financial Technology

ESTER – What You Need To Know

What You Need to Know about ESTER

We covered ESTER’s background in-depth during our previous blog, including the indices that ESTER beat in the race to be chosen as the Risk Free Rate (RFR) for Europe. In summary;

Why is ESTER Important?

Several reasons.

  1. EONIA (as it stands) will cease to meet “the criteria of the EU Benchmarks Regulation and will therefore see its use restricted as of 1 January 2020”. Hence ESTER will largely replace EONIA.
  2. EURIBOR will probably go the way of LIBOR with its’ existence beyond 2020 questionable. The chosen RFR in Europe, now defined as ESTER, will (probably) form the base for LIBOR fallbacks.
  3. EONIA is one of the most successful OIS markets around the globe. It is the only OIS market that sees significant outright volumes trade beyond two years. Transition from EONIA to ESTER must at the very least preserve this market structure – and hopefully see liquidity shift from EURIBOR swaps to ESTER swaps.
OIS activity by currency and tenor. EUR markets are the only OIS market that see substantial activity longer than 2 years.

Decision Time

Back in August, the public consultation on European RFRs (see our blog here) had found that 88% of respondents agreed that ESTER was the best replacement available for EONIA. That is convincing support for the new rate!

The three main points that respondents highlighted were:

  1. It is an unsecured rate – so as similar to EONIA as possible.
  2. Compilation methodology – note this doesn’t explicitly reference the volumes underlying the rate (which are lower than a secured rate) but it is transparent and easy to understand (no complex filtering of “specials” or by clearer).
  3. ECB is the administrator. So Central Banks are becoming the de-facto provider of rates. The RBA (AONIA), BoE (SONIA), BoJ (TONAR), Fed (SOFR, Fed Funds) and now the ECB (ESTER). Switzerland stands out as having SIX be the administrator of SARON here!

It looks like only the US (SOFR) and Switzerland (SARON) are going ahead with secured rates as their chosen RFRs.

ESTER History

Now that ESTER has been chosen as the preferred RFR, the ECB has also released “pre-ESTER” rates. These are rates using the same data as ESTER will use. (Although please note that cancelled trades are removed from pre-ESTER even if cancelled after 9am the following day. I can’t imagine this makes much difference?).

The rates are available from the ECB Statistical Warehouse.

So, onto the data….

ESTER Rates

The so-called “pre-ESTER” data is available back to March 2017:

ESTER

Armed with the data, the chart shows:

ESTER Volumes relative to EONIA

How do ESTER volumes compare to EONIA?

ESTER and EONIA volumes

This is covering a little bit of old ground, but it is worth stressing.

The chart shows that;

ESTER spread to EONIA

The transition to ESTER trading will be interesting. The starting point will be to look at the history of the rate relative to EONIA.

In the US, current basis spreads between Fed Funds and SOFR are razor-thin – the basis trading around 1 basis point last time that I looked. Will the spread between ESTER and EONIA be so tight?

ESTER spread to EONIA. ESTER is consistently lower.

Showing;

Who will be first?

Now we’ve got a defined RFR in Europe, who will be first to:

The race is on…..will it be the same players who traded the first SOFR swaps?

Admittedly, we will have to wait for the ECB to start publishing ESTER. This is stated “by October 2019.” It would be nice to see that date come forward, to “as soon as possible”.

In Summary

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