Luxembourg UCITS management companies and AIFMs must:
- identify which of the funds and sub-funds they manage are using benchmarks;
- consult the benchmark administrators about their plans to be registered with ESMA; and
- put in place a contingency plan in the event a benchmark can no longer be used.
The prospectus of a UCITS which uses a benchmark (as defined under the BMR) must disclose whether the benchmark administrator is registered with ESMA or not.
1. AIM OF THE BMR | 2. ARE YOU A BENCHMARK USER? | 3. WHICH BENCHMARK CAN BE USED? | 4. WHAT MUST BE INCLUDED IN THE CONTINGENCY PLAN? | 5. WHAT DISCLOSURES MUST BE MADE IN THE OFFERING DOCUMENTS OF FUNDS?
The purpose of this note is to summarise the impact on Luxembourg UCITS and AIFs of the EU Regulation 2016/1011 of 8 June 2018 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds (the Benchmarks Regulation or BMR).
1. AIM OF THE BMR
The BMR is a response to the LIBOR and EURIBOR scandals, where certain banks colluded to manipulate such benchmark interest rates. The main objective of the BMR is to restore investor trust in the accuracy, robustness and integrity of indices used as benchmarks in financial instruments and financial contracts or which are used to measure the performance of investment funds. The BMR intends to achieve this by introducing a common framework to regulate each stage: in the production of benchmarks to guarantee the absence of conflict of interest, in the contribution of data to calculate benchmarks so that benchmarks accurately reflect the market and in the use of benchmarks to ensure their appropriate use. As such the BMR applies to three categories: benchmark administrators (who produce benchmarks), benchmark contributors (who input data to benchmarks) and benchmark users.
The BMR rules on use of benchmarks apply to "supervised entities" that include among others AIFMs and UCITS management companies . Investment funds may thus fall within the scope of the BMR in case of use of certain benchmarks. To comply with the BMR, UCITS management companies and AIFMs must ensure that:
• they are aware of the benchmarks they use;
• the administrators of benchmarks used are registered with ESMA; and
• they have in place robust written contingency plans.
Although the BMR entered into force on 30 June 2016, most of the provisions only apply as from 1 January 2018, save for the use of certain benchmarks which benefit from a grandfathering period of two years.
2. ARE YOU A BENCHMARK USER?
The BMR does not define benchmark users per se but instead defines what constitutes use of a benchmark. First, we will focus on what a benchmark is as this determines the scope of the BMR.
A benchmark is defined as "any index by reference to which the amount payable under a financial instrument or a financial contract [i.e. EU consumer credit and residential mortgage agreements], or the value of a financial instrument, is determined, or an index that is used to measure the performance of an investment fund [i.e. UCITS and AIFs] with the purpose of tracking the return of such index or defining the asset allocation of a portfolio or of computing the performance fees ."
In other words, if a UCITS or AIF (or one of its sub-funds) uses an index to measure its performance with the purpose of tracking the return of such index or defining the asset allocation of a portfolio or of computing the performance fees, then the requirements under the BMR apply. Benchmarks used for information purposes only do not fall within the definition above.
An index is further defined as "any figure that is published or made available to the public and regularly determined:
• entirely or partially, by the application of a formula or any other method of calculation, or by an assessment; and
• on the basis of the value of one or more underlying assets, or prices, actual or estimated interest rates, quotes and committed quotes, or other values or surveys."
The Commission Delegated Regulation 2018/63 has clarified the concept of availability to the public. It provides that an index is considered as being made available to the public when:
• "it is made accessible to a potentially indeterminate number of legal and natural persons other than the index provider or other than a determined number of recipients connected or related to the index provider;
• it may be accessed by such persons either directly or indirectly as a result, inter alia, of its use by one or more supervised entities as a reference for a financial instrument it issues or to determine the amount payable under a financial instrument or a financial contract, or
to measure the performance of an investment fund, or to provide a borrowing rate calculated as a spread or mark-up over such figure; and
• where access may take place through a variety of media and modalities, set out by the provider or agreed between the provider and the recipients, free of charge or upon payment of a fee, including, but not limited to, telephone, file transfer protocol, internet, open access, news, media, through financial instruments, financial contracts or investment funds referencing the figure or by way of request to the users."
In other words, if the index is accessible to a large or potentially indeterminate number of persons or is accessible, directly or indirectly via one or more benchmark users that allow the use of the index within the meaning of the BMR, to an indeterminate number of persons, it will be deemed to be available to the public.
2.2 BENCHMARK USERS
Supervised entities are benchmark users if they:
(a) "issue a financial instrument that references an index or a combination of indices;
(b) determine the amount payable under a financial instrument or a financial contract by referencing an index or a combination of indices;
(c) are a party to a financial contract that references an index or a combination of indices;
(d) provide a borrowing rate (as defined in Article 3(j) of the Consumer Credit Directive ) calculated as a spread or mark-up over an index or a combination of indices that is solely used as a reference in a financial contract to which the creditor is a party; or
(e) measure the performance of an investment fund through an index or a combination of indices for the purpose of tracking the return of such index or combination of indices, of defining the asset allocation of a portfolio, or of computing the performance fees."
UCITS and AIFs using indices to measure performance, to define asset allocation, to track returns or to compute performance fees are therefore considered to be benchmark users.
ESMA has provided additional guidance in its Q & A on when a supervised entity will be viewed as a benchmark user in relation to derivatives (under b) above). A UCITS or AIF is a benchmark user if it enters into a derivative instrument based on a benchmark if the terms of the derivative (including the choice of the underlying benchmark) have not been set by the trading venue, the system internaliser or the central counterparty where the derivative is respectively traded or cleared.
The BMR exempts certain index providers and indices from its scope, such as EU and non EU central banks and public authorities or single reference prices for an individual security or derivative.
3. WHICH BENCHMARK CAN BE USED?
A supervised entity may only use a benchmark or a combination of benchmarks if they are produced by administrators included in the ESMA register for use. Such administrators will be in the register:
• for an EU administrator, if it is authorised (for benchmark administrators that provide critical benchmarks, commodity benchmarks, interest rate benchmarks or significant benchmarks) or registered (for supervised entities) under the BMR; or
• for a non-EU administrator, if it is added by equivalence (equivalence adopted by the EC), recognition (the country where the administrator is located has been recognised by a Member State) or endorsement (an administrator or supervised entity located in the EU with a clear and well-defined role within the control or accountability framework of a third country administrator and is able to monitor effectively the provision of a benchmark, applies for endorsement pursuant to the BMR).
However, there is a two-year grandfathering period (until 1 January 2020) for the following uses of benchmarks existing prior to the entry into force of the BMR (i.e. 30 June 2016):
• a benchmark provided by an index provider whose authorisation or registration as administrator is pending;
• where the use of a non-compliant benchmark is authorised by the competent authority of the Member State where the index provider is located (this may be the case if ceasing or changing such benchmark would result in a force majeure event, frustrate or otherwise breach the terms of any financial contract or financial instrument or the rules of any investment fund referencing that benchmark); and
• where a benchmark provided by a non-EU administrator (for the avoidance of doubt, not included in the ESMA register) is already used in the EU as a reference for financial instruments, financial contracts or for measuring the performance of an investment fund only for such instruments, contracts and measurements that already reference the benchmark in the EU, or which add a reference to such benchmark before 1 January 2020 .
4. WHAT MUST BE INCLUDED IN THE CONTINGENCY PLAN?
UCITS management companies and AIFMs that manage UCITS, AIFs or sub-funds thereof that use a benchmark pursuant to the BMR, must produce and maintain robust written contingency plans detailing the actions they will take in the event that a benchmark materially changes or ceases to be provided. Where feasible and appropriate, these plans should nominate one or several alternative benchmarks that could be referenced to substitute discontinued benchmarks, indicating why such benchmarks would be suitable alternatives. Supervised entities must, on request, provide the relevant competent authority with their plans and any updates to them, and must reflect them in the contractual relationship with clients (such as ISDA derivative contracts which provide for a designated fallback process in case of discontinuance of an index).
5. WHAT DISCLOSURES MUST BE MADE IN THE OFFERING DOCUMENTS OF FUNDS?
Disclosure requirements only apply to UCITS. If a UCITS (or one of its sub-funds) references a benchmark that falls within the scope of the BMR, the prospectus of the UCITS must disclose whether the administrator is registered on the ESMA list at the next update after 1 January 2018 and in any case prior to 1 January 2019. New UCITS funds and sub-funds launched after 1 January 2018 will have to immediately make such a disclosure.
For the avoidance of doubt, such disclosure requirements do not apply to AIFs.