No Fear of Discounting: How to Manage the Transition from EONIA to €STR

Abstract

An important step in the Financial Benchmarks Reform was taken on 13th September 2018, when the ECB Working Group on Euro Risk-Free Rates recommended the Euro Short-Term Rate €STR as the new benchmark rate for the euro area, to replace the Euro OverNight Index Average (EONIA) which will be discontinued at the end of 2021. This transition has a number of important consequences on financial instruments, OTC derivatives in particular.

In this paper we show in detail how the switch from EONIA to €STR affects the pricing of OIS, IRS and XVAs. We conclude that the adoption of the "clean discounting" approach recommended by the ECB [2], based on €STR only, is theoretically sound and leads to very limited impacts on financial valuations.

This finding ensures the possibility, for the financial industry, to switch all EUR OTC derivatives, either cleared with Central Counterparties, or subject to bilateral collateral agreements, or non-collateralised, in a safe and consistent manner. The transition to such EONIA-free pricing framework is essential for the complete elimination of EONIA before its discontinuation scheduled on 31st December 2021.

Keywords: BMR, ECB, EMMI, EURIBOR, EONIA, €STR, benchmark rate, interest rate, risk-free rate, overnight rate, discounting, yield curve, bootstrapping, derivative, pricing, OIS, IRS, XVA, FVA

JEL Classification: C60, E43, G12, G13, G15, G18