October 2022
The market for financial benchmarks continues to develop and evolve and so does the regulation. Recent updates from UK and European regulators set out clear expectations of how Benchmark Administrators (BAs) should operate under the existing framework. There are a number of proposals to change and expand the regulatory framework which could have impact on BAs’ business models and strategy. Currently the benchmark regulation (“BMR”), commonly referred to as the EU BMR in Europe and UK BMR within the UK are largely identical. Some of the proposed regulatory changes and supervisory expectations highlight how the regulation may start to evolve and be applied in the two jurisdictions. By reviewing these latest updates, BAs can assess whether their current operations are meeting expectations and ensure that their future business planning takes account of the developing regulatory environment.
FCA supervisory strategy (UK BMR)
The FCA recently outlined its supervision priorities (PDF 215 KB) for BAs as: disclosure, quality of data and data controls, operational resilience, oversight and governance, and competition.
On disclosure, the FCA is concerned that BAs have not accurately described the economic reality that their benchmarks measure, particularly those related to ESG. It has also observed that benchmark administrators broadly grouping their benchmark families for the purposes of their benchmark statements, for example, at an asset class level, can lead to poor disclosure. The FCA will continue to monitor the quality of disclosures made by BAs and further scrutinise the construction and labelling of ESG benchmarks.
The FCA used the letter to again highlight its continuing concern about the use of credit sensitive rates as replacement for LIBOR given the small underlying market. UK regulated benchmark administrators are requested to continue to notify the FCA in advance if they intend to administer these rates.
BAs should also notify the FCA if they are intending to administer cryptoasset benchmarks — as the FCA is concerned that data inputs to cryptoasset benchmarks often measure fragmented and opaque markets.
The letter states that the FCA will conduct multi-firm work on the quality of data including non-price data inputs. In preparation, BAs should review their processes and controls that monitor the quality of the input data to benchmarks as well as the correct implementation of their stated methodology. These processes must also cover data from third parties. The FCA expects BAs to notify it of incidents relating to data quality, including non-price data inputs, taking into account the usage of the benchmark.
Oversight of third-party data input and services are also highlighted as key to maintaining operational resilience around benchmarks. The FCA is concerned poor operational resilience may have caused incidents such as late publication, non-publication and calculation errors which could impact the reliability of benchmarks. The FCA plans to do a baseline assessment of operational resilience of BAs in Q4 2022 or Q1 2023.
Finally the letter also highlights that although benchmark administration activities are not within scope of the new FCA Consumer Duty, it is likely to apply to other firms in the distribution chain of products in which benchmarks are used. Therefore, the FCA expect BAs to support users of their benchmarks in meeting their obligations under the Duty.
EU Benchmarks Regulation reform
In the EU, the European Commission is seeking views (PDF 378 KB) on how the EU Benchmarks regulation (EU BMR) may need to be amended. The rules around the use of benchmarks issued by third-country (i.e. non-EU) administrators need the closest attention. EU BMR only allows the use of third-country benchmarks in the EU if the BA applies for recognition (by ESMA), endorsement (by an EU BMR registered administrator or supervised entity) or its home jurisdiction's regime is deemed equivalent by the Commission. Third-country benchmarks are under a grace period until 31 December 2023 where the use of third-country benchmarks not yet compliant with the BMR is permitted.
Around 330 third-country administrators are currently providing benchmarks in EU, however only 11 (3%) are authorised under one of the third-country regimes. A significant number of UK based BAs have become third-country administrators to the EU post Brexit. Therefore, there may be a large cliff edge at end 2023 with access to benchmarks considerably reduced for EU regulated firms.
In its consultation, the Commission proposed the concept of 'strategic' third-country benchmarks which would fall under requirements of BMR — all other third-country benchmarks would then be free to use. The definition of strategic could be related to notional value, globally or in the EU, type of use or user, type of benchmark or regulatory status of the administrator in the home jurisdiction.
ESMA and market participants have generally welcomed this proposal from the Commission, supporting the simplification and reduction of the regulatory burden of the regime. However, there are some concerns.
If the definition of a strategic benchmark was only applied to third-country benchmarks, then this would create an unlevel playing field, disadvantaging EU benchmark administrators as their whole range of benchmarks would still be subject to the full EU BMR regime.
The regulation already defines three different types of benchmark by impact: critical; significant and non-significant. Feedback suggests that it would be better to streamline these definitions rather than add in a fourth definition.
The UK on-shored the BMR but extended the third-country grace period to 31 December 2025. It remains to be seen whether the UK will adopt similar changes to the final changes made by the EU or whether the UK will propose different amendments once the end of its grace period becomes nearer.
ESG benchmarks
The ESG data, ratings and benchmarks market is also growing considerably. The European Commission is scoping whether there should be a specific EU ESG benchmark label (alongside the existing climate transition and Paris-aligned labels). The only regulatory requirements applicable to ESG benchmarks are disclosure requirements as defined in the 2020 delegated regulation. ESMA believes that these disclosure requirements are not sufficient to ensure an adequate level of harmonisation between the different ESG benchmarks. The introduction of an EU ESG benchmark label could reduce greenwashing by increasing transparency around methodologies. However, ESMA highlights that creation of a new ESG label would have to be aligned with other EU sustainable finance regulation.
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