The CME Term €STR Reference Rates provide a forward-looking measurement of overnight €STR based on market expectations implied from derivative market transactions and quotes.
Why CME Term €STR
Reliable: can be produced in all market conditions
Robust: calculated using a proven methodology
Representative: underpinned by liquid €STR markets
CME Term €STR is a new term-based reference rate, provided by CME Group Benchmark Administration Limited, the administrator of CME Term SOFR. It is the only Term €STR rate whose calculation is primarily grounded in daily transactions and official exchange marker prices. With over €135B of transaction data, on average, used in the calculation daily, CME Term €STR is a robust rate, underpinned by representative input data.
Figure 1: Average daily input data volume (Jan-24 to Jun-24)
The calculation is based upon a proven methodology, developed in conjunction with central bank economists [for Term SOFR],1 to accurately represent future expectations of €STR for 1-, 3-, 6- and 12-months.
The CME Term €STR reference rates provide a reliable, robust and representative rate for firms requiring a fallback to EURIBORⓇ or a primary forward-looking euro term interest rate to use in new products. A detailed CME Term €STR methodology is published on the CME Group website.
- Underpinned by over €135B in average daily volume
- Calculated using a proven, robust methodology, building on the work of central bank economists
- Utilizes the same calculation engine as CME Term SOFR, the only endorsed Term SOFR rate
- Provided by a regulated benchmark administrator, for use in Europe, the UK and Globally
Euro Interest Rate Benchmarks: Current State
What is the current state of interest rate benchmarks in the euro area and how does CME Term €STR complement the current offering?
EURIBOR®
Most of the euro-denominated financial products that are referencing a floating rate are currently using EURIBORⓇ (Euro Interbank Offer Rate). EURIBORⓇ measures the cost of wholesale funding of credit institutions in the unsecured euro money market. EURIBORⓇ is widely used in euro mortgages, derivative transactions and commercial financing.
The EURIBORⓇ benchmark is calculated based on daily contributions from panel banks. Due to the limited activity in the underlying inter-bank market, fewer than 35% of contributions are based on transaction data for the 1-month, 3-month, 6-month and 12-month tenors.
Unlike other contribution-based benchmarks, such as LIBOR, there's currently no plan for the cessation of the EURIBORⓇ. Firms, however, should ensure that they have adequate fallbacks2 in place in their EURIBORⓇ products and contracts.
CME Term €STR, as a euro reference rate, makes a robust fallback for EURIBORⓇ. Including CME Term €STR as a fallback provides a representative alternative which can be readily utilized should EURIBORⓇ become unavailable or cease to be published.
Euro short-term rate (€STR)
As part of benchmark reform, the European Central Bank created €STR reflecting the wholesale unsecured overnight borrowing costs of banks located in the euro area. €STR is utilized in derivative markets and some cash products where a compounded in arrears rate is suitable for the market.
€STR is calculated based on overnight fixed rate deposit transactions between financial counterparties. Average daily volume underpinning €STR is greater than €50B.
The overnight €STR rate has seen increasing uptake over the last 5 years, particularly in the swaps and more recently futures market. Now the derivatives market has become well established, a robust Term €STR rate can be established, utilising the €STR derivatives market as input. According to the ECB working group report, some cases such as mortgages or consumer loans will require a rate with a “forward-looking term structure methodology” for the reference period. This is where CME Term €STR comes in.
CME Term €STR provides a forward-looking euro term reference rate for 1-, 3-, 6- and 12-months. This allows users to have greater certainty in markets where it is preferred to know the rate in advance.
CME Term €STR Input Data
What makes CME Term €STR so reliable, robust and representative?
The CME Term €STR calculation is grounded in a methodology [originally] designed in conjunction with central bank economists, and also utilized to calculate the CME Term SOFR rates. We are combining liquid 3-month €STR futures with aggregated transactions from the deep €STR overnight index swap (OIS) market, to calculate a forward-looking €STR term rate.
€STR overnight index swaps (OIS)
In order to create the most reliable representation of the expected forward path of €STR, we utilize OIS transaction data within the calculation. The OIS market is currently the largest €STR derivatives market. We are utilizing the most liquid parts of the OIS market, taking both spot starting swaps (3-, 6-, 12-months) as well as the first two ECB-dated swaps.
ECB-dated swaps are forward starting swaps that start and end on an ECB maintenance period start date. During the swap period, the ECB deposit and lending rates remain constant. Therefore, large numbers of market participants transact these swaps to hedge their €STR exposure during these windows.
The breakdown of swap volume utilized in the CME Term €STR calculation is presented in Figure 2 below. The average aggregated daily volume is around €135B. CME Group is the only Term ESTR provider that currently includes ECB-dated swaps in the calculation of the rates. ECB-dated swaps make up the majority of short-dated OIS activity in the euro market.
Figure 2: Average volume of the €STR OIS used in the CME Term €STR calculation
CME €STR futures
CME Three-Month €STR futures reflect euro overnight interest rate expectations between quarterly International Money Market (IMM) dates. The contract represents one of the leading pools of centralized liquidity on the euro short-term rate (€STR).
By utilizing the €STR futures data in the Term €STR calculation, we’re able to obtain greater granularity of the market's expectations for overnight €STR for the next 12 months. Since the launch of €STR futures, they have grown to over 60,000 contracts in open interest (see Figure 3). This represents approximately €60B of open interest currently in the market. Over 75% of CME €STR futures open interest is held by end users. This means the futures inputs to CME Term €STR are underpinned by users looking to transfer risk.
In utilizing the official 4:00 p.m. London Marker prices the Term €STR calculation will have a robust set of futures prices, to enhance the outputs of the projection model. This will ensure a robust, reliable and representative Term €STR rate.
Figure 3: CME €STR futures open interest (Nov-22 to Aug-24)
CME Term €STR Calculation
How does the projection model create the representative Term €STR rates?
The overall methodology is designed to project the expected overnight €STR rates in between ECB Maintenance Periods. The model utilizes a piecewise constant step function, which calculates the expected increase or decrease of €STR after ECB interest rate policy meetings.
The calculation is based on the Broyden-Fletcher-Goldfarb-Shanno algorithm. It utilizes the five OIS rates (3-month OIS, 6-month OIS, 12-month OIS, first ECB Dated OIS and second ECB Dated OIS) combined with five quarterly CME €STR futures prices to create the expected €STR rates over the next 12 months (red path on the below graph).
Figure 4: Projection model’s input data and path of the €STR rates (data for the July 19, 2024)
The expected €STR rates are then compounded to create the 1-, 3-, 6- and 12-month CME Term €STR rates.
Outline of CME Term €STR Methodology
What steps go into producing the daily CME Term €STR Reference Rates?
The CME Term €STR Reference Rates Methodology uses a combination of three-month €STR futures, spot starting €STR swaps and €STR ECB-dated swaps to ensure that the term structure is appropriately calculated, providing as many data points as possible.
A detailed methodology document can be found on the Term €STR website.
Input data
CME €STR futures
We will incorporate the official 4:00 p.m. London Marker prices of the first five CME 3-Month €STR futures into the projection model. The contracts reflect euro overnight interest rate expectations between IMM dates.
€STR OIS transactions data
We’ll utilize five different OIS transaction inputs within the calculation:
- Three spots starting €STR OIS with tenor 3-, 6- and 12-month.
First and second ECB-dated swap period (a ECB-dated swap is a swap starting on an ECB maintenance start date and ending on the following one).
All those OIS trades are provided to CME Group as aggregated inputs by tenor into two data sets:
- Data by tenor for the 2:15 p.m. - 7:00 p.m. CET period
- Data by tenor for the 9:00 a.m. - 7:00 p.m. CET period
€STR OIS quotes data
For both spot starting and ECB-dated swaps, we will receive dealer-to-client quote data from a leading marketplace.
For each tenor, the administrator will compute an afternoon median and a full-day median that reflect the quotes from various dealers across the day.
Calculation of the Term €STR rates
Waterfall methodology
The CME Term €STR Reference Rates are calculated using a waterfall calculation to ensure sufficient data is available for each OIS input, prior to being combined with the €STR futures data to be used in the projection model. The waterfall for the OIS data is made up of the four levels listed below.
Figure 5: CME Term €STR calculation waterfall
Level 1: VWAP of the OIS transactions from 1:15 p.m. to 6:00 p.m. GMT. The VWAP is calculated for each tenor. The aggregation of the OIS transactions is using a statistical technique that removes the outliers.
Level 2: VWAP of the OIS transactions from 8:00 a.m. to 6:00 p.m. GMT. The VWAP is calculated for each tenor. The aggregation of the OIS transactions is using a statistical technique that removes the outliers.
Level 3: The afternoon quote median for the given tenor.
Level 4: The full-day quote median for the given tenor.
Modeling forward rates
CME Group determines the path of overnight €STR rates by assuming the overnight €STR rates follow a piecewise constant step function and can only jump up or down on the ECB Policy Maintenance start date and remain constant within the ECB Policy Maintenance period. Though the overnight rates are not directly observable, we utilize CME €STR futures contracts and the €STR swap market to obtain estimates of overnight €STR on average over the specific contract reference periods. With these references as inputs, the optimal path for the overnight €STR rates is determined such that the errors between the model-implied prices and the observed market prices are minimized.
The framework of the optimization method is guided by the following principles:
Reflect market expectations. The first and second term of the optimization function is the weighted average squared error between implied values and observed prices of 5 CME Three-Month €STR futures (ESR) contracts, and 5 OTC swaps. The optimization algorithm is trying to minimize the mean-squared errors of the deviations from market expectations.
Equivalent importance of inputs. We assign each input price the same level of importance with respect to the contribution to the error function in the optimization. The weight for each futures contract and swap contract is 0.1.
Eighteen-month jump window. We assume that no jumps will occur more than eighteen months after the as of date.
Policy gradualism. The second term of the optimization function is a penalty function which will impose punishment on large jump sizes
Finally, term rates will be constructed by compounding overnight €STR rates following specific conventions.
References
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
