The Benchmark Regulation ensures that benchmarks are robust and reliable. It also minimises conflicts of interest in the benchmark determination processes. For products and services with benchmarks subject to the Benchmark Regulation, benchmarks that comply with the Regulation must be used.
Entities subject to supervision in the European Union must comply with the obligations relevant to them under the Benchmark Regulation. BNG is an entity subject to supervision within the meaning of the Benchmark Regulation and is therefore subject to (certain) obligations under this Regulation. For parties with whom BNG has entered into a credit and/or derivatives agreement with an interest rate benchmark, questions and answers are provided below about what the transition to interest rate benchmarks means for them.
See the questions and answers from: The European Working Group on Risk-Free Rates of the European Central Bank (ECB) / The European financial regulator European Securities and Markets Authority (ESMA)
These questions form an integral part of the amendment agreement for the inclusion of fallback provisions in the credit/derivatives agreement.
A benchmark is an index that is updated on a regular basis. A benchmark is used to measure a certain economic reality, such as the return or value of financial products, a bank's funding costs or the (relative) performance of an investment.
An interest rate benchmark, also known as a base rate, reference rate or interest rate, can be used to determine, among other things, the interest payable or receivable under a credit or derivatives agreement and the value of the credit or derivative.
The Benchmark Regulation contains rules to improve the way in which interest rate benchmarks are determined (the determination methodology). The Benchmark Regulation requires interest rate benchmarks to be reliable, transparent and robust. An interest rate benchmark must measure economic reality as representatively as possible (reliable), the method used to determine an interest rate benchmark must be clear and verifiable (transparent), and an interest rate benchmark must be determined more on the basis of observable transactions in the market that are sufficiently large and representative of the economic reality being measured (robust/objective) and less on the basis of estimates (‘quotes’) from banks.
After 1 January 2022, only benchmarks that comply with the Benchmark Regulation may be used for products and services with benchmarks subject to the Benchmark Regulation. For credit and derivative agreements entered into on or after this date, this means that only an interest rate benchmark (reference interest rate) that complies with the Benchmark Regulation may be included in the agreement.
All credit and derivative agreements, including those entered into before 1 January 2022 (current agreements), must include a provision allowing for the choice of €STR or an interest rate benchmark based on €STR if one of the following events occurs:
The moment at which one of these events occurs may be before 1 January 2022. Such a contractual provision is known as a fallback clause. Banks and other financial institutions are required to include fallback clauses in agreements that use interest rate benchmarks. For existing agreements, this can be done by entering into an amendment agreement. For more information about €STR, see question 6.
As a result of the global financial crisis following the collapse of Lehman Brothers in 2008 and the sovereign debt crisis in Europe, there was a sharp decline in the number of interbank money market transactions that form the basis for the calculation of interest rate benchmarks. This was partly due to the European Central Bank (ECB) buying up bonds and tightening liquidity requirements for banks. The structural decline in market liquidity meant that interest rate benchmarks, i.e. Interbank Offered Rates (IBORs), could be based on actual transactions to an increasingly limited extent. This weakened the quality of the interest rate benchmarks, as the determination based on estimates (‘quotes’) from banks became increasingly subjective. This culminated in the London Interbank Offered Rate (LIBOR) scandal in 2012. It then became clear to the public that interest rate benchmarks were susceptible to manipulation due to the way in which they were determined.
In response to these events, international standards have been developed to improve the way in which financial benchmarks are set (the ‘IOSCO Principles for Financial Benchmarks’). In Europe, the international standards have been translated into the European Benchmark Regulation. The rules are intended to ensure that benchmarks are based more on actual transactions and are therefore less susceptible to manipulation. There will also be supervision of benchmark administrators and rules for benchmark users.
The administrators of the current European interest rate benchmarks, including the Euro OverNight Index Average (“Eonia”) and the Euro InterBank Offered Rate (“Euribor”), have been instructed to strengthen these benchmarks. This has already been done for Euribor (see question 7). In the case of Eonia, it has been determined that it cannot be strengthened (see question 6).
Eonia is the abbreviation for Euro OverNight Index Average and is the so-called risk-free interest rate benchmark in the Eurozone. A working group of the European Central Bank (ECB), the European Working Group on Risk-Free Rates, has conducted research into alternatives to Eonia. On 13 September 2018, this working group decided to recommend the Euro Short-Term Rate (€STR) as the new risk-free interest rate benchmark in the euro area to replace Eonia. Eonia is now often used to settle interest on cash collateral obtained or deposited.
The exact date of the transition from Eonia to €STR depends on a number of factors. The ECB has set the latest transition date as 1 January 2022. The current administrator of Eonia, the European Money Markets Institute (EMMI), has announced that it will publish Eonia for the last time on 3 January 2022. In practice, the market (and BNG) may also switch to using €STR earlier. This moment will be determined by developments in the market. The more Eonia is replaced by €STR, the faster the entire market, including BNG, will switch to using €STR. See also question 4 in this regard.
In order to ensure a smooth transition to €STR, Eonia has been published on the basis of €STR + 8.5 basis points (0.085%) since 2 October 2019. The ECB determined this spread on the basis of the daily Eonia and the so-called ‘pre-€STR data’ from mid-April 2018 to mid-April 2019. Because the determination methods for Eonia and €STR are not the same (see also questions 3 and 8), a correction method in the form of a spread is needed in order to measure the same economic reality with €STR as with Eonia. Eonia measures a bank's funding costs for unsecured loans with a maturity of 1 day (overnight unsecured funding costs) in the interbank market, while €STR measures this in the wholesale market.
Because €STR is determined on the basis of more money market transactions (the wholesale market is larger than the interbank market, as it includes not only transactions between banks, but also transactions between banks and, among others, money market funds, insurers and pension funds), there is more volume and liquidity, which means that the price/rate of €STR is lower than Eonia. This difference has been set at 8.5 basis points. Between 2 October 2019 and 3 January 2022, both interest rate benchmarks will coexist.
Euribor is the abbreviation for Euro InterBank Offered Rate. The current administrator of Euribor, the European Money Markets Institute (EMMI), has strengthened the methodology for determining Euribor. The new determination methodology, referred to as the hybrid method, meets the criteria of the Benchmark Regulation (see question 3). The Euribor rate gradually transitioned to the hybrid Euribor in the fourth quarter of 2019 and will be published for at least five years. After this period, Euribor may cease to exist or may no longer be considered representative of the economic reality (see questions 1 and 2). It is therefore important to include fallback provisions in credit and derivative agreements that use Euribor as the contractual interest rate benchmark (see questions 4 and 12).
The question then arises as to which replacement interest rate benchmark can be designated on the basis of the fallback provisions for Euribor. The ECB's European Working Group on Risk-Free Rates has recommended that only €STR or an interest rate benchmark based on €STR should be permitted as a replacement interest rate benchmark if an event occurs that requires a replacement interest rate benchmark to be provided (see also question 4). Euribor and €STR do not measure the same economic reality. Euribor measures a bank's funding costs in the interbank market for unsecured short-term loans with maturities of 1 week and 1, 3, 6 and 12 months. Due to the different maturities of the underlying transactions (loans) on which the Euribor rate is based, there are several Euribor rates: the 1-week Euribor and the 1-, 3-, 6- and 12-month Euribor. The €STR measures a bank's funding costs in the wholesale market for unsecured loans with a maturity of 1 day, known as wholesale overnight unsecured funding costs (see also questions 6 and 8). Due to this difference in the underlying economic reality, the Euribor cannot be replaced by the €STR, but it can be replaced by an interest rate benchmark based on the €STR.
In order for an interest rate benchmark based on €STR to measure the same economic reality as Euribor, the additional components included in Euribor will have to be taken into account, such as the term premium that banks have to pay for purchasing liquidity with a specific maturity, for example the premium for the 6-month liquidity and credit risk in the case of the 6-month Euribor rate. This requires a correction methodology in the form of a spread. The replacement interest rate benchmark for Euribor is then expected to be a so-called term €STR or €STR with a correction spread. Depending on the type of contract and the availability of term €STR, either €STR or term €STR will be chosen as the basis.
The ECB's European Working Group on Risk-Free Rates is tasked with developing recommendations for the transition to a replacement interest rate benchmark with as little impact as possible in areas such as value changes, accounting and processes.
€STR is an overnight interest rate benchmark that reflects the wholesale overnight unsecured funding costs in euros of banks in the euro area (see also question 6). The European Central Bank (ECB) is the administrator of €STR. It compiles €STR on the basis of the transactions that banks report to the ECB on a daily basis as part of their money market statistical reporting (MMSR). €STR has been chosen as the alternative risk-free interest rate benchmark for the euro area and will gradually replace Eonia (see also question 6). The ECB has been publishing €STR daily since 2 October 2019.
Because the current interest rate benchmarks Eonia and Euribor and the interest rate benchmarks that will replace Eonia and Euribor (€STR for Eonia and an interest rate benchmark based on €STR for Euribor) do not measure the same economic reality (see also questions 1 and 2), a correction methodology in the form of a spread (a ‘correction spread’) is needed in order to measure the same economic reality and to make the transition as smooth as possible (in terms of representativeness, valuation, accounting, transparency, robustness, etc.). Question 6 explains the correction methodology for the transition from Eonia to €STR. Question 7 explains the correction methodology for the transition from Euribor to an interest rate benchmark based on €STR. The answers to both questions also discuss in more detail the need to apply a correction spread.
Under current market conditions, €STR is fixed lower than Euribor, which represents a positive risk premium for credit and liquidity risk for the longer fixed-interest term of Euribor compared to €STR. This positive risk premium will be determined and translated into a correction spread, i.e. a correction surcharge. A correction surcharge also applies to a transition from Eonia to €STR. This has been set at 8.5 basis points (see question 6). In principle, the correction surcharge will be fixed once at the time of the transition.
BNG is preparing thoroughly for the transition to new interest rate benchmarks. BNG is monitoring developments closely and taking measures to implement the changes optimally and limit risks as much as possible. Among other things, BNG has identified the processes and services and products in which benchmarks are used and the terms of these products.
Based on this inventory, BNG has drawn up fallback provisions for credit and derivative agreements with an interest rate benchmark that the bank has entered into with customers on the basis of its own model documentation. These fallback provisions will be incorporated into an existing agreement by means of an amendment agreement or, in the case of recently entered into agreements, have already been incorporated into the agreement from the outset. Based on the fallback provisions, BNG may, if necessary, designate a replacement interest rate benchmark, thereby providing an alternative to the current contractual interest rate benchmark (‘fallback’). BNG has also drawn up a plan setting out what we will do if a benchmark used by us ceases to exist. This is required by law. The Netherlands Authority for the Financial Markets (AFM) supervises this plan.
Customers who have entered into a credit and/or derivatives agreement with BNG with Euribor or Eonia as the contractual interest rate benchmark will receive an amendment agreement to include so-called fallback provisions in the current agreement. This is the case if the agreement does not yet provide for fallback provisions (recently concluded agreements already contain fallback provisions). Based on the fallback provisions, BNG may, if necessary, designate a replacement interest rate benchmark, thereby providing an alternative to Euribor or Eonia (‘fallback’). Based on current market developments, BNG will designate €STR as the replacement interest rate benchmark for Eonia (€STR has been designated as the new risk-free interest rate benchmark in the euro area to replace Eonia; see also questions 6 and 8) and expects to designate an interest rate benchmark based on €STR as the replacement interest rate benchmark for Euribor (see also question 7). Because the current interest rate benchmarks and the replacement interest rate benchmarks do not measure the same economic reality (see also questions 1 and 2), a correction methodology in the form of a spread (a ‘correction spread’) is needed to ensure a smooth transition (in terms of representativeness, valuation, accounting, transparency, robustness, etc.). The how and why of applying a correction methodology is explained in more detail under question 9.
Banks and other financial institutions are required to include fallback clauses in agreements that use benchmarks. For more information, see question 4. On the basis of fallback clauses, BNG may, if necessary, designate a replacement interest rate benchmark (€STR or an interest rate benchmark based on €STR), thereby providing an alternative to the current contractual interest rate benchmark (‘fallback’). This will allow current credit and derivative agreements to continue after 1 January 2022 (as of this date, only benchmarks that comply with the Benchmark Regulation may be used for products and services with benchmarks that fall within the scope of the Benchmark Regulation).
The manner in which fallback clauses can be included in a new or existing agreement depends on the type of credit or derivative agreement with an interest rate benchmark. This is due to differences in definitions and contractual (general or specific) provisions.
BNG has drawn up fallback provisions for credit and derivative agreements with an interest rate benchmark that the bank has entered into with customers on the basis of its own model documentation. These include the financing agreement, the (financing) agreement for banking services, the loan agreement (FRL, FLEX, Rollover, FLEXTRA), the current account agreement, the financial services agreement and the framework agreement for financial derivatives. On 10 June 2020, BNG sent a letter with an addendum (amendment agreement) to all its customers with one or more of the aforementioned agreements that do not yet contain fallback provisions, with a view to incorporating fallback provisions into the current agreement.
Customers who have entered into a credit agreement with BNG based on the standard documentation of the Stichting Waarborgfonds voor de Zorgsector (the ‘WfZ’) or the Stichting Waarborgfonds Sociale Woningbouw (the ‘WSW’) that does not yet include fallback provisions will be informed separately about the inclusion of fallback provisions. This also applies to customers who have entered into a credit agreement with BNG based on the standard documentation of the Loan Market Association (LMA) and/or a derivatives agreement based on the standard documentation of the International Swaps and Derivatives Association (ISDA).
The ECB's European Working Group on Risk-Free Rates has recommended that only €STR or an interest rate benchmark based on €STR be permitted as a replacement interest rate benchmark if an event occurs that requires a replacement interest rate benchmark to be provided (see question 4 for details of these events). Currently, only €STR is available, but a forward €STR is being developed. The fallback provisions that BNG has drawn up for credit and derivative agreements with an interest rate benchmark (see question 13) stipulate that BNG may designate a replacement interest rate benchmark that complies with these requirements.
When designating a replacement interest rate benchmark, BNG will base its decision on instructions or recommendations from central banks, supervisory authorities or other relevant authorities or organisations and what it considers to be customary practice in the market in the context of the transition to an alternative interest rate benchmark in comparable products, if and insofar as such instructions, recommendations or market practice are available. Based on current market developments, BNG will designate €STR as the replacement interest rate benchmark for Eonia (€STR has been designated as the new risk-free interest rate benchmark in the euro area to replace Eonia; see also questions 6 and 8) and expects to designate an interest rate benchmark based on €STR as the replacement interest rate benchmark for Euribor (see also question 7).
Because the current interest rate benchmarks and the replacement interest rate benchmarks (€STR for Eonia and an interest rate benchmark based on €STR for Euribor) do not measure the same economic reality (see also questions 1 and 2), a correction methodology in the form of a spread (a ‘correction spread’) is needed in order to measure the same economic reality and to ensure that the transition is as smooth as possible (in terms of representativeness, valuation, accounting, transparency, robustness, etc.). Under current market conditions, €STR is fixed lower than Euribor, which represents a positive risk premium for credit and liquidity risk for the longer fixed-interest term of Euribor compared to €STR. This positive risk premium will be determined and translated into a correction spread, i.e. a correction surcharge. A correction surcharge also applies to a transition from Eonia to €STR. This has been set at 8.5 basis points (see question 6). In principle, a correction surcharge will be determined once at the time of the transition. For clarity, the correction surcharge must be distinguished from a surcharge for the credit risk that the bank runs on a customer (referred to in certain credit agreements as the “Spread”). If a periodic (spread) review has been agreed, the existing contractual procedure for a periodic (spread) review will apply. In the market, the correction methodology is being developed under the supervision of the European financial supervisory authorities.
BNG will switch to designating a replacement interest rate benchmark as soon as market conditions warrant this. Reasons for this may include the contractual interest rate benchmark no longer being published or available, BNG no longer being permitted to use it, or the contractual interest rate benchmark no longer being reliable or representative or no longer being suitable for use in the agreement for any other reason. This may also occur before 1 January 2022.
The replacement interest rate benchmark will take effect on an interest payment date. There will therefore be no fractional interest periods (when switching from Euribor to a replacement interest rate benchmark; this does not apply to Eonia, as this is a daily interest rate).
If you have any further questions, please contact your account manager.
No, BNG does not have freedom of choice in designating the replacement interest rate benchmark and cannot interpret the correction spread methodology itself, nor can it determine the level of the correction spread. In this regard, BNG follows the instructions and recommendations of supervisory authorities, authoritative working groups and industry organisations. However, the text of the fallback provisions allows BNG, where desirable and possible, to provide customised solutions within the margins permitted under the Benchmark Regulation by entering into bilateral agreements with the customer. This may be desirable, for example, in the case of variable-rate long-term loans whose interest rate risk is hedged with one or more interest rate derivatives (see also question 19). By providing insight into the European benchmark transition process, it will become clear that the inclusion of fallback provisions in current agreements is in the interests of both parties, the bank and the customer, and that the process ensures that there can be no arbitrariness on the part of financial institutions in implementing these provisions. We therefore explain this process below.
The European benchmark transition and its consequences for financial institutions and customers is a difficult subject to grasp, because it involves many technical aspects. It concerns the setting of interest rates and the various methodologies behind this, which can differ depending on the type of financial product. Specific to the benchmark transition is the question of how the transition from an existing interest rate benchmark (base rate) to a replacement interest rate benchmark can be achieved with as little impact as possible in areas such as value change, accounting and processes. Because the current interest rate benchmarks and the replacement interest rate benchmarks do not measure the same economic reality (see also questions 1 and 2), a correction methodology in the form of a spread (a “correction spread”) is needed to achieve a smooth transition in terms of representativeness, valuation, accounting, transparency, robustness, etc. (For more details, see question 9).
In 2018, the European Central Bank (ECB) established a working group, the European Working Group on Risk-Free Rates (hereinafter: “European RFR Working Group”), which, in close consultation with the market and financial regulators, is considering methodologies to make the benchmark transition as “party-neutral” as possible. It has called on authoritative industry organisations to provide input on consultations and to make proposals and recommendations for their specific markets (ISDA for derivatives, LMA for syndicated loans, ICMA for bond issues and AFME for securitisations).
Various recommendations have been made by the European RFR Working Group and industry organisations. These have been submitted to market parties for consultation in order to achieve the best possible and most widely supported transition. However, the work is not yet complete. As a result, a number of issues remain unclear and uncertain. This concerns not only the actual moment of transition to a replacement base rate as a result of the current interest rate benchmark no longer being available, reliable, representative or suitable (this cannot be predicted in advance; see question 4 for more details), but also the question of whether the fallback option will be the same for all financial product types. Various aspects form part of the fallback option that will ultimately be recommended to the market by the European RFR Working Group for each type of financial product on the basis of recommendations from industry organisations, including the methodology for determining the replacement interest rate benchmark and the methodology for the correction method. The methodology for determining the replacement interest rate benchmark includes questions such as: “What will be the replacement interest rate benchmark, €STR or an interest rate benchmark based on €STR (the 'forward €STR”)?“, and: 'Which interest rate convention and payment date convention will apply?”. Several methodologies are possible for the correction methodology, each with its own characteristics that need to be worked out, such as in the case of the ISDA for the
The fallback option is currently only fixed for the derivatives market. ISDA has determined a uniform fallback option for the derivatives market after consulting its members/market parties. The fallback option for credit products has not yet been determined. Consultations on this are still ongoing. Among other things, consideration is being given to whether the credit market can align with the fallback option and the methodology chosen by ISDA for the derivatives market. This is particularly important for variable-rate long-term loans (FRL/FLEX/Rollover) whose interest rate risk is hedged with one or more interest rate derivatives. If the European RFR Working Group ultimately recommends a different fallback option for variable-rate long-term loans, it may no longer be possible to achieve a “perfect hedge”. It is possible that the European RFR Working Group's recommendation for the final fallback option for credit products will distinguish between credit products offered to large corporate customers and credit products offered to consumers and small and medium-sized enterprises.
Due to the complexity of the many issues surrounding the benchmark transition, this is a time-consuming process. In the meantime, financial institutions are required to respond to the upcoming benchmark transition in a timely and adequate manner. One of the requirements imposed by financial regulators (and on which financial institutions must report) is that financial institutions must provide new and existing derivative and credit agreements with an interest rate benchmark with so-called fallback clauses in a timely manner to prevent problems arising for the institutions and their customers due to the current interest rate benchmarks no longer being available, reliable, representative or suitable nature of the current interest rate benchmarks. Financial institutions must therefore take action and ensure that fallback clauses are included in new and existing agreements, even though much remains unclear and uncertain. See also questions 4 and 12 on the importance of fallback clauses.
BNG was one of the first Dutch banks to take this step by proposing to its customers that they include fallback clauses in existing credit and derivative agreements with a base rate, drawn up on the basis of BNG's own model documentation in a bilateral relationship (i.e. not for syndicated loans, LMA documentation, model agreements of the WSW and WfZ, and ISDA documentation). It based the text of the fallback provisions on the recommendations for drafting fallback provisions issued by the European RFR Working Group and the proposed texts for fallback provisions issued by international industry organisations. In doing so, it took market conformity into account. BNG and various other banks have been including similar fallback provisions in new credit agreements for some time.
As not everything is known yet, BNG has included words such as “the bank intends” and “in the opinion of the bank” in the text of the fallback provisions. However, this does not mean that BNG is free to designate a replacement base rate or determine a correction spread at its own discretion and (thereby) apply the fallback provisions unilaterally in its favour.
BNG has no discretion in designating the replacement interest rate benchmark and cannot determine the methodology for the correction spread or its level. It follows the instructions and recommendations of supervisory authorities, authoritative working groups and industry organisations and considers what constitutes best market practice (if any). However, where possible and desirable, after the customer has accepted the fallback provisions, the bank may agree with the customer to align the fallback options for the variable-rate long-term loan and the interest rate swap that the customer has entered into to hedge the interest rate risk of this loan by opting for the ISDA methodology for both products (see also question 19). In order to be able to provide this and any other customisation within the margins permitted under the Benchmark Regulation, a more general and flexible wording has been deliberately chosen to describe how the bank will implement the fallback provisions. This explains why, in a few places in the text of the fallback provision, the words “the bank may” and “the bank's right to implement changes to the agreement that it deems necessary or desirable” have been used (see, among other things, sub c of the fallback provisions).
Yes, the interest rate transition under an RFD will in principle take place at the same time and under the same conditions as the transition under ISDA documentation.
At present, it is still unclear whether the same recommendations for the fallback option will apply to the transition of loans and interest rate swaps, as different authorities are involved for both products and the associated model documentation (see also question 17). However, we can agree with you in advance to follow the ISDA system and recommendations for the transition of loans in order to prevent any risk of no longer having a “perfect hedge”. If you wish to do so, please contact your account manager as soon as possible.
See also questions 9 and 14 about the correction methodology. At the request (call) of the European Working Group on Risk-Free Rates established by the ECB in 2018, industry organisations, after consulting their members/market parties, are making recommendations for correction methodologies as part of the possible fallback options for financial products with an interest rate benchmark. Based on this, the working group will make a formal recommendation for the most widely supported methodology for each type of financial product. A market party will then be sought to calculate and publish the correction methodology. For example, Bloomberg calculates and publishes the correction methodology chosen by ISDA for the derivatives market. BNG is therefore unable to determine the correction methodology itself, nor can it determine the size of the correction spread. BNG follows the instructions and recommendations of the European Working Group on Risk-Free Rates and industry organisations (see also question 17).
On the recommendation of the Working Group on Risk-Free Rates, which it set up in February 2018 for the purpose of the benchmark transition, the ECB has designated the Euro Short-Term Rate (€STR) as the new risk-free interest rate benchmark in the euro area to replace Eonia. The ECB has also determined that a correction spread of + 8.5 basis points (0.085%) must be applied in order for the €STR to measure the same economic reality as Eonia (see also questions 6, 7 and 9 on the need to apply a correction spread).
The European Working Group on Risk-Free Rates has recommended that Euribor should only allow €STR or an interest rate benchmark based on €STR (i.e. €STR with a term structure, hereinafter referred to as a “term €STR”) as a replacement interest rate benchmark. Currently, only €STR is available. The European Working Group on Risk-Free Rates is working on a term €STR. It is not yet known when this term €STR will be available and what the liquidity of the interest rate benchmark will be.
The fallback option has currently only been determined for the derivatives market. ISDA has determined a uniform fallback option for the derivatives market after consulting its members/market parties. The fallback option for credit products has not yet been determined. Consultations on this are still ongoing.
The European Working Group on Risk-Free Rates is expected to launch two consultations in the course of 2020, with completion planned for early 2021. These consultations will concern the preferred fallback option for credit products with Euribor as the interest rate benchmark and a number of specific situations in which the fallback option for Euribor comes into effect (‘trigger events’). BNG will inform its customers as soon as it is known which fallback options the European Working Group on Risk-Free Rates recommends for credit products with Euribor as the interest rate benchmark.