The Benchmarks Regulation (BMR) – or to give it its long name, the Regulation on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds ((EU) 2016/1011) – aims to ensure the accuracy, robustness and integrity of benchmarks and of the benchmark determination process. The majority of the BMR’s provisions applies from 1 January 2018, but – due to transitional provisions – some important provisions are only scheduled to take effect in 2020 and some might even – given recent legislative initiatives – be partially postponed until 31 December 2021. As of end of 2021, all benchmarks used in the EU and their administrators are then, at the latest, required to fully comply with the BMR – what does this mean for benchmark users and what should be done this year to prepare?
The BMR sets out a regulatory framework for providers of benchmarks (administrators), contributors of input data to a benchmark (contributors) and users of benchmarks alike. It has a surprisingly broad scope. All supervised entities in the EU (including banks, investment firms and Alternative Investment Fund Managers pursuant to the AIFM Directive) are affected by the BMR, given the endless number of instruments using indices (for example, to determine interest rates, as underlying, or to ascertain performance fees).
Need to act
Supervised entities will, broadly speaking, only be allowed to use benchmarks from 1 January 2020 onwards if the benchmark complies with the BMR and is administered by an authorised or registered benchmark administrator. With regard to critical benchmarks (such as LIBOR and EURIBOR) as well as all third country benchmarks, we currently expect the end of the transitional period to be pushed to the end of 2021. Benchmarks that do not comply with those requirements cannot be used (anymore), resulting in the need to change affected agreements and instruments. In particular, banks and investment firms issuing securitised derivatives, and supervised counterparties to over-the counter (OTC) derivatives, need to prepare for this change.
The BMR obliges supervised users to develop emergency plans by preparing robust, written plans setting out the actions that they would take in the event of cessation or transition of an index, or if an index is no longer eligible for use under the BMR. No transitional period applies to this obligation. Given the plans for the cessation of both LIBOR and EURIBOR, it is very likely that those emergency plans need to be applied within the next two years and hence should be sufficiently detailed and robust to actually work in practice. Further, the impact of Brexit needs to be considered: UK benchmark administrators will be considered third country administrators as of the time of a Hard Brexit and then need to obtain a new registration as a third country administrator. Those administrators may though be able to benefit from the above-outlined legislative initiative prolonging the transitional period for use of third country benchmarks to the end of 2021.
Emergency planning needs to cater for the different kinds of products using benchmarks. It also focuses on mandatory changes to the contracts and their documentation.
In this vein, the International Swaps and Derivatives Association (ISDA), for example, published inter alia its Benchmark Supplement. The document seeks to address requirements under the BMR but is drafted generically to also address market participants outside the scope of the BMR. Akin, an updated 2018 version of the German Master Agreement is also available, providing rules to address cessation and transition of indices. As the German Master Agreement does not provide for a protocol mechanism, the new rules will need to be negotiated with each counterparty.
Other kinds of contracts may also need to be considered for emergency planning when using indices. Those contracts may or may not provide for rules dealing with substitute benchmarks or mechanisms addressing the cessation of an index. Often they only provide – for historic reasons – rules addressing the temporary cessation of a benchmark. As a result, the parties might have a significant commercial interest in negotiating a new solution. If the parties did not envisage the cessation risk at the time the contract was entered into, under German law, a legal right of each party to request an amendment of the agreement in line with what parties would have entered into had they foreseen the issue when originally negotiating the agreement might be available.
With regards to bonds, even more complex issues might arise, such as the potential need to call for a bond holder assembly. Depending on the kind of bonds in question, consent of all bond holders might be mandatory to change terms. In some cases, there might even be a need to consider a public exchange offer to address the BMR risk. All of this could amount to a practical impediment for compliance with the BMR – and in any case requires early planning.
All users of benchmarks need to identify instruments using benchmarks and plan their next steps to minimise any potential disruption to their businesses. These steps need to take account of the different timeframes the BMR provides for – but also consider the planned cessation of IBORs and the impact of Brexit.