Commission proposal will affect benchmark administrators and submitters well beyond LIBOR: The regulatory interest in benchmarks prompted by the manipulation of LIBOR has now extended into many other areas of the financial system: what began as a banking issue has evolved into a system-wide concern, with potential regulatory impacts for a wide range of firms. Under a new proposal for a Regulation published today by the European Commission, virtually all published benchmarks and indices used as references for traded instruments, financial contracts, and measuring fund performance are set to be covered by the EU's new regime.
What's covered?
Earlier work focused on inter-bank rates and commodity benchmarks, but the scope of today's proposal is very broad, perhaps more so than expected. While inter-bank rates and commodity benchmarks have their own sector-specific Annexes, all other benchmarks will be subject to the general requirements of the proposal. This means that any published benchmark used to reference a financial instrument on a regulated venue, used in a financial contract such as a mortgage, or used to measure the performance of an investment fund, will be captured by the proposal if any formula or calculation is applied to the value of underlying assets to determine an index figure. There are very few exemptions, and other than where explicitly spelled out in the text it would appear that the whole universe of benchmarks and indices is covered, from interbank rates, to commodity benchmarks, stock exchange indices, and proprietary indices.
Who is affected?
Firms need to be aware of the proposals for two main reasons: firstly, they may be performing activities which could be construed as administering a benchmark under the Regulation; and secondly they may be submitting information which is used as an input for a benchmark. There are consequences for firms if they do either of these. Governance and internal controls are in focus, and while the burden will be greater for administrators, particularly as they will have to be explicitly authorised as such, submitters are also subject to various requirements. In particular, the Commission proposes that both parties sign a legally binding 'code of conduct', and has set out detailed and prescriptive requirements for oversight arrangements.
What should firms do now?
There are some basic steps that should be taken on the basis of today's proposal. First, firms will need to catalogue and assess the risks of any price-setting processes which may fall within the scope of the proposed Regulation. This will require them to assess whether they are administrators or submitters. If so, it will be necessary to assess current oversight arrangements for these activities, and benchmark them against the requirements in the proposal, identifying any shortfalls. Ultimately, they will need to think about the risks of their involvement in price-setting processes, particularly given the potential penalties and sanctions involved, and the reputational damage that accompanied the LIBOR scandal.
Work is already underway at some firms to understand their activities in this area. Today's proposal will help firms in this work, providing further clarity on what is in and out of scope. But clearly this is not the end of the road – the proposal will be negotiated and amended, and there is sure to be pushback from certain parts of the industry that do not agree with the way benchmark regulation has spread to non-bank parts of the system. Nevertheless, today's proposal provides a benchmark against which firms should measure themselves, while they keep an eye on how the proposal evolves.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
