EMMI enhancements to Efterm Methodology

The European Money Markets Institute (EMMI) has concluded its first annual review of the Efterm Methodology. The changes only affect level 3 of Efterm waterfall methodology and intend to mitigate month-end effect of future prices, use European Central Bank (ECB) key policy announcements as a guide to interest rates trajectory, and align the level 3 calculation to the underlying market spot starting convention.

The Current Efterm Methodology

The existing Efterm methodology operates across three levels:

Level 1 €STR-based OIS tradeable bid and offer prices.

Level 2 involves €STR-based OIS dealer-to-client bid and offer prices.

Level 3 utilizes a step function model with €STR-linked futures' settlement prices, €STR rates, and the ECB reserve maintenance periods calendar.

Motives behind the 1^st methodology review

To ensure that Efterm rates are representative of the underlying market, EMMI, together with the Calculation Agent[1], conduct daily surveillance checks on Efterm rates. The checks detected small discrepancies in the Efterm level 3 rates when compared to the published rates calculated using level 2 of the waterfall methodology in shorter term tenors.

The intent behind the suggested changes to the methodology is to harmonize the Efterm rates computed with both levels of the methodology, thereby guaranteeing that the benchmark accurately reflects the underlying market independently of the level used for publication.

Consequently, the proposed changes solely focus on fortifying the robustness of level 3 of the methodology, with no changes to the first two levels.

Enhancements for level 3 of the methodology

Enhancement 1: Not using Futures at the end of the month

To address discrepancies, we will not use futures to project a rate change in the current month if there are seven or fewer calendar days remaining in the current month. This reduces the impact of external factors and rounding effects on rate projections. Instead, the latest published €STR rate will simply continue until the rate change date in the next calendar month.

Enhancement 2: Using ECB rate changes in preference to Futures rates, once they have been announced

In the period between an ECB rate announcement and the start of the new maintenance period, the ECB rate change offers a more accurate guide to €STR behaviour than do the Futures prices. The new projected €STR rate will instead be derived by applying the delta in the ECB Deposit Facility rate to the latest €STR.

Enhancement 3: Spot Starting Convention

Aligning with money market convention, this enhancement proposes using a spot starting (T+2 business days) convention for Level 3 computations, ensuring consistency with level 1 and level 2 calculations.

Material Change Assessment and Considerations

EMMI's Benchmark Consultation Policy guides the evaluation of material changes. The Efterm oversight committee concluded that the proposed enhancements do not constitute a material change to the Efterm methodology.

While the addition of ECB Deposit Facility Rate could be perceived as new input data, the proposed changes are limited to level 3 and do not alter the nature and purpose of the calculation. In addition, the adjustments apply within a specific period—between the rate announcement following an ECB monetary policy meeting and the first day of the closest maintenance period.

Striving for precision

The proposed enhancements are meant to improve Efterm’s robustness and reliability. This evaluation also ensures Efterm accurately represents the market's economic reality and avoids contributing to artificial volatility.

The methodology changes will be effective from 25 January 2024.

[1] ICE Benchmark Administration Limited (IBA) is EMMI's calculation agent for Efterm. Input data for Efterm is provided “as is” by data providers. IBA, data providers and its and their affiliates owe no duty of care to users or recipients of Efterm and will not be liable to users or recipients of EFterm in relation to Efterm or the input data in any way whatsoever, whether under tort, contract, misrepresentation, restitution, breach of statutory duty, or otherwise under any applicable law save for any liability which by law may not be excluded. None of IBA, any data providers, or any of its or their affiliates make any claim, prediction, warranty, or representation whatsoever, express or implied, in relation to Efterm, the input data, or the appropriateness, suitability, or fitness of Efterm or the input data for any particular purpose to which it might be put and all warranties and representations of any kind, express or implied, are excluded.