The first half of 2023 has seen a renewed focus on EURIBOR fallbacks, with both the Working Group on Euro Risk-Free Rates (the Euro Working Group) and the LMA publishing new guidance. What should parties to new EURIBOR-based transactions be doing now to take this into account?  

Recommendations and market response

Back in May 2021, the Euro Working Group published recommendations on EURIBOR fallback trigger events and €STR-based EURIBOR fallback rates. These included a recommendation to add €STR-based fallbacks to all EURIBOR-based cash products, including corporate loans, trade and export finance products, debt securities and securitisations. The Euro Working Group's recommendations gained limited traction in the loan markets, with parties to most EURIBOR-based transactions preferring to continue using "traditional" IBOR fallbacks (including interpolated rates and cost of funds) together with "replacement of screen rate" language. This has left EURIBOR as something of an outlier – on most term SOFR and compounded RFR transactions, parties usually include "permanent" fallbacks based on alternative published benchmarks, in particular central bank rates.

Undeterred, the Euro Working Group published a further note in May 2023 specifically aimed at encouraging participants in the corporate lending market to adopt its 2021 recommendations. For corporate loans, the Euro Working Group's recommendations are, broadly, to include a fallback to compounded €STR, but with the option of making term €STR the first fallback rate, followed by compounded €STR. Possible reasons that these recommendations have not been widely adopted to date include:

• The complexity of adding compounded RFR mechanics into a EURIBOR-based facility agreement. This tends to be more of a concern in single currency facilities. Most multicurrency facility agreements include compounded RFR formulae and other RFR mechanics anyway for use with other currencies. 
• A reluctance to use a backward looking rate (compounded €STR) to replace a forward looking rate (EURIBOR) – ideally, a fallback should work operationally in a similar way to the primary rate it is replacing.
• The lack of any recommended published credit adjustment spreads to account for the economic difference between EURIBOR and compounded €STR (equivalent to the LIBOR spreads published by Bloomberg for ISDA in 2021).
• Previous lack of a published term €STR. At the time of the Euro Working Group's 2021 recommendations, no term €STR existed. This has now changed, with EMMI EFTERM and Refinitiv Term €STR both now in publication (albeit the latter only in prototype form). 
• A perception that including €STR-based fallbacks is "not LMA". Although the LMA's multicurrency facility agreements have for some time included mechanics for a compounded reference rate to apply as a fallback in place of a term reference rate, they have not provided for this to apply for euro loans. However, in March 2023 the LMA published a note emphasising that market participants can adopt the Euro Working Group's recommendations using the current LMA facility agreements by: 
  • designating euro as a "Rate Switch Currency"; and
  • providing that no Backstop Rate Switch Date applies in relation to EURIBOR.

What's next?

We have seen some evidence of greater appetite to adopt the Euro Working Group's recommendations since its May 2023 publication, without any major shift in market approach. It remains to be seen whether the market will ultimately adopt these recommendations, or perhaps adopt alternative permanent fallbacks. For example, now that use of a fixed central bank rate fallback has become the norm in term SOFR transactions, will the euro loan market adopt a similar approach? 

Whether they choose to adopt the Euro Working Group's recommendations or an alternative, market participants may wish to look again at their approach to EURIBOR fallbacks. During the long LIBOR transition process, regulators decided to leave EURIBOR largely untouched. Now that all currencies and tenors of LIBOR have finally been discontinued (save for synthetic versions of one, three and six month USD LIBOR), the long term future of EURIBOR may come under renewed scrutiny.