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As you may have noticed LCH changed the basis of discounting it applies to cleared EUR transactions from EONIA to ESTR on 24 July. It was announced well in advance but the event itself seems to have gone largely unnoticed.
Of course EONIA will be with us until January 2022 so there is plenty of time to replace it as the interest rate in bilateral EUR CSAs before it is discontinued but should you be making the change in bilateral EUR CSAs now?
The answer is, of course, "it depends" but there is now a misalignment between discount rates applied in cleared and uncleared EUR OTC derivatives. For some people this will not matter as they do not have large cleared portfolios or the amount of EUR collateral being posted is not significant but for those with large portfolios, particularly those which are directional and so involve the prevalent posting of collateral in one direction, it might be, at least over time.
If participants are not concerned with the differential then they can just change their EUR CSAs at any time before January 2022 and include the 8.5 basis point spread to ESTR so that there is no economic change occurring. However, those for whom the differential is meaningful are likely to want to change much sooner and seek to not include the spread so that the cleared and uncleared portfolios are discounted on the same basis. This inevitably means some economic adjustment potentially requiring compensation but at least this eradicates the basis upfront before the effect accumulates or becomes more significant at a later date when the compensation to make the change could be higher. So for a number of participants it will make sense to make the change sooner rather than later.
ISDA have produced a draft Amendment Agreement to address the switch from EONIA to ESTR, not just in terms of CSAs but also trade cash-flows which currently reference EONIA. This specifically contemplates an option to include the 8.5 basis points spread and an option for compensation being paid for agreeing to the switch .
There is a similar pending issue for USD CSAs which is a much bigger universe as USD cash collateral is much more common than EUR collateral. A typical USD CSA will currently reference Fed-Funds for the accrual of interest on the collateral posted. Whilst there is no suggestion that Fed-Funds will be discontinued (unlike EONIA) there is an announced change to the discount rate that will be applied by LCH (and other CCPs) on cleared USD trades from October 2020.
With that in mind ISDA are now drafting another Amendment Agreement which will, in the same document, cater for both changes and it is expected that those participants who which to address both issues may do the necessary repapering at the same time rather than undertake the exercise on a more prolonged or repeated basis.
If you wish to discuss this issue with us, please get in touch with your usual contact here or any of those below. In addition, both our Condor alternative legal solutions team and the Fieldfisher Consulting team would be happy to discuss their experience with portfolio digitisation, repapering exercises or quantitative portfolio analysis.Guy Usher, Partner | London
Steven Burrows, Senior Associate | London
Stephen Ingle, Head of Condor (Alternative Legal Solutions) LLP
Haseeb Haque, Managing Partner, Fieldfisher Consulting | London
Ashwani Roy, Partner, Fieldfisher Consulting | London