Euro Overnight Index Average EONIA Definition Switch to ESTER

Euro Overnight Index Average (EONIA) Definition

The Euro Overnight Index Average (EONIA) is a benchmark interest rate that represents the average interest rate at which Eurozone banks lend to each other overnight. It is calculated by the European Central Bank (ECB) and is widely used in financial markets as a reference rate for various financial instruments.

Overview of the Euro Overnight Index Average (EONIA)

EONIA is calculated based on the actual transactions and quotes submitted by a panel of Eurozone banks. The calculation is done using a weighted average method, where the weight of each bank’s contribution is determined by its size and activity in the overnight lending market.

EONIA is published on a daily basis and represents the interest rate for the previous business day. It is typically used as a reference rate for short-term financial products, such as money market funds, derivatives, and floating rate loans.

Historically, EONIA was calculated based on actual transactions in the unsecured interbank lending market. However, due to the financial crisis in 2008 and the subsequent concerns about the reliability of interbank lending rates, the methodology for calculating EONIA was revised.

Since October 2019, EONIA has been calculated as a hybrid rate, combining the actual transactions with a theoretical component based on the Euro Short-Term Rate (ESTER). This transition was made to align EONIA with the new benchmark rate, ESTER, which is considered more robust and representative of the Eurozone money market.

Switch to Euro Short-Term Rate (ESTER)

ESTER is based on actual transactions in the wholesale euro money market and reflects the borrowing costs of euro area banks. It is calculated by the ECB and provides a more accurate and transparent measure of the overnight borrowing costs in the Eurozone.

The switch from EONIA to ESTER is expected to improve the accuracy and representativeness of the benchmark rate, as well as enhance the overall stability and integrity of the Eurozone financial markets. It will also align the Eurozone with international best practices in benchmark rate calculation.

EONIA	ESTER
Based on unsecured interbank lending rates	Based on actual transactions in the wholesale euro money market
Historical benchmark rate	New benchmark rate introduced in October 2019
Less robust and representative	More robust and representative

Overview of the Euro Overnight Index Average (EONIA)

The Euro Overnight Index Average (EONIA) is a benchmark interest rate that is widely used in the eurozone financial markets. It represents the average interest rate at which eurozone banks lend to each other on an overnight basis. EONIA is calculated and published by the European Central Bank (ECB) and is considered a key reference rate for short-term euro-denominated transactions.

EONIA is calculated using a weighted average of the interest rates reported by a panel of banks, which are based on actual transactions that occurred in the interbank market. The rate is calculated and published on a daily basis, reflecting the interest rates for the previous business day.

The EONIA rate is used as a benchmark for various financial products and transactions, including derivatives, loans, and bonds. It is commonly used as a reference rate for determining the interest rates on loans and mortgages, as well as for pricing and valuing financial instruments.

As a result, the ECB has decided to replace EONIA with a new benchmark rate called the Euro Short-Term Rate (ESTER). ESTER is designed to address the shortcomings of EONIA and provide a more reliable and representative benchmark for the eurozone financial markets.

ESTER is based on actual transactions and reflects the borrowing costs of eurozone banks in the wholesale unsecured market. It is calculated using a methodology that is consistent with the principles set out by the International Organization of Securities Commissions (IOSCO) for benchmark rates. ESTER is expected to be more resilient to market disruptions and manipulation, and to provide a more accurate reflection of the underlying market conditions.

The switch from EONIA to ESTER is planned to take place in October 2019. The transition will involve a change in the methodology used to calculate the benchmark rate, as well as adjustments to the contracts and financial instruments that reference EONIA. Market participants are advised to prepare for the transition and ensure that their systems and processes are ready to accommodate the new benchmark rate.

Switch to Euro Short-Term Rate (ESTER)

The Euro Short-Term Rate (ESTER) is a new overnight interest rate that has been introduced as a replacement for the Euro Overnight Index Average (EONIA). The switch from EONIA to ESTER is part of the European Central Bank’s (ECB) efforts to improve the accuracy and reliability of the benchmark interest rate used in the euro area.

ESTER is calculated based on actual transactions in the wholesale unsecured overnight borrowing and lending market. This means that it reflects the real cost of borrowing for banks and financial institutions, making it a more reliable indicator of short-term interest rates in the euro area.

The switch to ESTER brings several benefits. First and foremost, it enhances the accuracy and integrity of the benchmark interest rate. By using actual transaction data, ESTER provides a more transparent and reliable measure of short-term interest rates, reducing the risk of manipulation or distortion.

Furthermore, the switch to ESTER improves the comparability of interest rates across the euro area. As ESTER is based on actual transactions, it provides a common reference point for financial institutions and market participants, facilitating the pricing and valuation of financial products.

The transition from EONIA to ESTER has been carefully planned and executed. The ECB has provided guidance and support to market participants to ensure a smooth and orderly transition. The switch to ESTER has been widely adopted by banks, financial institutions, and market infrastructures, further enhancing its credibility and acceptance in the market.

Benefits of Switching to Euro Short-Term Rate (ESTER)

The switch from Euro Overnight Index Average (EONIA) to Euro Short-Term Rate (ESTER) offers several benefits for market participants and regulators. Here are some of the key advantages:

1. Enhanced Accuracy:

ESTER is based on a larger volume of transactions and incorporates a wider range of market participants, resulting in a more accurate representation of the euro area money market. This increased accuracy provides a more reliable benchmark for financial products and reduces the risk of manipulation.

2. Robustness and Resilience:

ESTER is designed to be more resilient to market disruptions and shocks. It includes a wider range of eligible counterparties and incorporates a broader set of transactions, making it less susceptible to manipulation or distortions caused by a small number of participants.

3. Consistency with International Standards:

The switch to ESTER aligns the euro area with international best practices and recommendations. ESTER is based on the principles set out by the International Organization of Securities Commissions (IOSCO) and the Financial Stability Board (FSB), ensuring consistency and comparability with other global short-term interest rates.

4. Improved Risk Management:

ESTER provides a more accurate and reliable measure of the cost of borrowing in the euro area money market. This improves risk management for financial institutions, allowing them to make more informed decisions and better assess the creditworthiness of their counterparties.

5. Enhanced Transparency:

ESTER offers greater transparency compared to EONIA. The publication of ESTER includes detailed information on the underlying transactions, contributing to a more transparent and efficient money market. This increased transparency benefits market participants, regulators, and investors alike.

6. Facilitation of Benchmark Transition:

The switch to ESTER facilitates the transition away from EONIA as a benchmark rate. As EONIA is being phased out, market participants need to adapt their systems and contracts to reference alternative rates. The availability of ESTER as a robust and reliable alternative simplifies this transition process.