Changing overnight: ISDA 2021 EONIA Collateral Agreement Fallbacks Protocol published

• United Kingdom

• Financial services and markets regulation - Derivatives
• Financial services

19-08-2021

 

On 18 August 2021, the International Swaps and Derivatives Association Inc., (“ISDA”) published the ISDA 2021 EONIA Collateral Agreement Fallbacks Protocol (the “EONIA Protocol”).

The EONIA Protocol is a multilateral amendment mechanism allowing market participants to replace references in their collateral agreements to the European overnight index average (“EONIA”) with references to the euro short-term rate (“€STR”) plus a spread of 8.5 basis points.  The change to the reference rate will be effective when EONIA ceases to be published on 3 January 2022.  The EONIA Protocol also incorporates fallbacks into in-scope contracts which will apply in the event of the permanent cessation of €STR.

Background

In February 2018, the European Money Market Institute (“EMMI”), acting as administrator of EONIA, announced that EONIA would not comply with the requirements of the EU Benchmark Regulation (the “EU BMR”) when those requirements come into force from 1 January 2022.  The wind-down of EONIA was subsequently commenced and, on 13 September 2018, the working group on euro risk-free rates (the “Euro Working Group”) recommended €STR as the rate to replace EONIA. 

On 14 March 2019, the Euro Working Group published recommendations on euro risk-free rates transition from EONIA to €STR, which included a transition period during which the methodology for calculating EONIA would be modified and based on €STR and the method to determine the spread adjustment between €STR and EONIA.

On 31 May 2019, the European Central Bank (the “ECB”) calculated a one-off spread between EONIA and €STR of 8.5 basis points (determined by the ECB to reflect the economic differences between EONIA and €STR).  The ECB has published EONIA using the recalibrated methodology since 2 October 2019.  Also on 31 May 2019, the EMMI announced the discontinuation of EONIA as a benchmark effective from 3 January 2022.  

Data submitted to the Euro Working Group suggests that a significant number of EONIA referencing collateral agreements without appropriate fallback provisions remain in place and should be updated.  The EONIA Protocol provides a mechanism to market participants to implement those updates. 

Effect of the EONIA Protocol

The EONIA Protocol incorporates certain provisions of Version 2.0 of the ISDA Collateral Agreement Interest Rate Definitions (the “Collateral Rate Definitions”) into all “Protocol Covered Documents” between adhering parties.  The EONIA Protocol replaces references to EONIA contained in the Protocol Covered Documents with references to the definition of “EONIA (Collateral Rate)” contained in the Collateral Rate Definitions.  For further information on the Collateral Rate Definitions, see our previous briefing: Overnight sensation: ISDA publishes new definitions to facilitate transition from EONIA.     

This definition of EONIA (Collateral Rate) provides that, on 3 January 2022 (or any prior date on which it is announced that EONIA will cease to be available), the relevant rate will be €STR plus a spread of 8.5 basis points (which mirrors the existing EMMI methodology for the calculation for EONIA, referred to above).  The Collateral Rate Definitions also provide fallbacks that apply if €STR ceases to be available.

Collateral agreements published by ISDA (including among others, the 2016 Credit Support Annex for Variation Margin (VM) and 1995 ISDA Credit Support Annex) entered into between two adhering parties are Protocol Covered Documents for the purposes of the EONIA Protocol.  The full list of Protocol Covered Documents are set out in the EONIA Protocol.

If the parties have already amended a collateral agreement that would otherwise be in scope of the EONIA Protocol in order to incorporate fallbacks in respect of EONIA, then that collateral agreement will fall outside of the scope of the EONIA Protocol.

Adherents to the EONIA Protocol should ensure they are comfortable with the population of contracts that fall in-scope of the EONIA Protocol.  In particular, parties should consider whether €STR plus a spread of 8.5 basis points is the appropriate replacement rate in the context of particular collateral agreements.     

As with similar protocols published by ISDA, market participants can adhere to the EONIA Protocol in their capacity as agent for multiple clients.  

Other ISDA initiatives

ISDA has previously published documents allowing parties to amend collateral documents bilaterally. These bilateral documents include Version 1.0 of the Collateral Agreement Interest Rate Definitions (containing definitions for EONIA and €STR) and Version 2.0 of the Collateral Agreement Interest Rate Definitions (covering a broader range of rates).  By incorporating these definitions into collateral agreements, parties can include standardised definitions in their collateral agreements with fallbacks that apply if the relevant rate is permanently discontinued or temporarily fails to be published.

ISDA has also published various template forms of amendment agreements to allow the parties to update the rates on a bilateral basis.

Tough legacy

On 3 August 2021, the European Commission issued a consultation on a draft delegated act¹ which would designate €STR plus an 8.5 basis point spread as the statutory replacement rate for EONIA in accordance with Article 23a of the EU BMR (which prescribes the European Commission’s ‘tough legacy’ powers).  This follows the “recommendation on the EONIA to €STR legal action plan” as set out in a letter from the chairman of the EUR Risk-Free Rates Working Group to the European Commission. 

Although the decision of the European Commission to exercise its ‘tough legacy’ powers under Article 23a of the EU BMR is a welcome development and forms part of the derivatives market’s wider transition efforts, market participants should note that the decision does not apply to all collateral contracts.  

Only contracts subject to the laws of a Member State and / or between parties which are established in the EU and which is subject the laws of a jurisdiction that does not provide for the orderly wind-down of a benchmark are in Scope of Article 23a.

Collateral agreements under the laws of New York or England and Wales that involve a non-EU established entity will not, for example, fall in scope of Article 23a.

Even where collateral agreements are between two EU-established entities, it is not clear whether the governing laws of particular jurisdictions would be considered to provide for the orderly unwind of EONIA (as EONIA would not be in scope of New York or UK tough legacy powers). 

Market participant should therefore take care if seeking to rely upon any draft delegated act under Article 23a of the EU BMR only.  The EONIA Protocol (and the bilateral templates published previously by ISDA) provide greater legal certainty and should continue to be the preferred market solution.

 

For further guidance on the ISDA 2021 EONIA Collateral Agreement Fallbacks Protocol, please get in touch.

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1. Commission Implementing Regulation (EU) on the designation of a replacement for benchmark European overnight index average in contracts and financial instruments as referred to in Article 23a of Regulation (EU) 2016/1011 of the European Parliament and of the Council.