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Why the Euribor benchmark underwrites liquidity in times of market stress


June 2023

When macro-economic events send tremors through global markets, investors need a quick and reliable way to hedge their risk. This March, concerns around the banking sector saw many turn to a futures and options contracts backed by the decades-old money market benchmark – Euribor.

It resulted in a new record: 49.5 million Euribor futures and options contracts were traded in March 2023, surpassing the last monthly high posted in January 2013. Meanwhile, open interest in the options market remains around levels not seen for a decade, as the current rising rate cycle drives demand.

The UK Financial Conduct Authority phased out the LIBOR rate, which was the primary benchmark for setting short-term interest rates around the world. Yet eurozone regulators took a different approach and the Euribor benchmark, which is set by surveying a panel of European banks, remains as strong as ever today. The methodology which underpins Euribor has been strengthened in recent years and it continues to be used across trillions of dollars of financial instruments, including retail products.

It now operates in parallel with the latest risk-free overnight rate, €STR (euro short-term rate), which reflects the actual overnight borrowing costs of banks within the eurozone.

Both interest rate benchmarks serve a purpose, and the market continues to support Euribor futures and options contracts in times of stress.

Familiarity, simplicity and flexibility

Familiarity is a key reason why Euribor endures as an interest rate benchmark. Euribor contracts are well understood, which carries weight in an uncertain economic environment. This understanding leads to support, creating a transparent and fair market that aims to retain investor confidence.

Simplicity is another factor. Euribor term rates out to 12 months make it easier for corporates to hedge their interest rate risk compared to the more complex calculations that accompany a risk-free overnight rate. It allows them to focus on their core business, rather than concerning themselves with the nuances of various financial markets.

There is also an element of flexibility to the Euribor benchmark. It has a built-in credit component because it represents an uncollateralized cost of borrowing by a bank, whereas an overnight risk-free rate is based on wholesale trades. Many market participants believe that a short-term rate with an inbuilt credit component better serves the needs of lenders and borrowers. Amid a backdrop of higher interest rates, this component becomes even more important for price discovery of risk.

Therefore, Euribor provides trading opportunities for market participants, allowing them to take leveraged positions in a more cost-efficient way. The result is greater liquidity across the entire market, reducing costs for all participants.

The ultimate test

The greatest test of any benchmark remains how it functions under the stress of a shock event.

European Money Markets Institute CEO Jean-Louis Schirmann says, “Published since 1999 in parallel with the introduction of the euro, Euribor withstood various global crises and has proven its robustness. However, we are committed to strengthening it on a daily basis, ensuring its sustainability, representativeness, and transparency for the future."

The March collapse of Silicon Valley Bank, quickly followed by Signature Bank, was a recent example. It prompted a rapid change in risk sentiment, together with record levels of derivatives activity driven by a flight to liquidity.

Futures markets have historically performed under all stressed market conditions. On March 13, a record 14.45 million futures and options were traded across ICE's markets, outpacing the 14.39 million contract record last set on March 12, 2020, during the onset of the pandemic.

As investors continue to digest fallout from rising inflation, the depth of Euribor liquidity is set to play a key role in helping them manage market uncertainty.

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What is Euribor?

  • Euribor is a euro money market benchmark calculated for five maturities: one week, and one, three, six and 12 months.
  • It measures ‘the rate at which wholesale funds in euro could be obtained by credit institutions in current and former European Union and European Free Trade Association countries in the unsecured money market’.
  • Euribor was declared a critical benchmark by the European Commission in 2016 because of its systemic importance for financial stability. The total outstanding amount of financial instruments and contracts using Euribor as a reference exceeds €100 trillion.

Source: The European Money Markets Institute