Selecting a benchmark and its provider was so far mainly a function of product development and marketing. Providers of comprehensive families of indices offer more scope for future products, providers with brands known to the general public may support marketing efforts. A recent Commission proposal for a new regulation on indices used as benchmarks in financial instruments and financial contracts may add new selection criteria should it finally be adopted.

Is(n't) the KIID good enough?

Since the advent of the "UCITS IV" rules set out in Directive 2009/65/EC, fund management companies are required to provide their clients with a key investor information document (Commission Regulation (EU) No 583/2010), since then generally known as "KIID" (and already widely commented upon). In particular, the KIID must describe the fund's investment objectives and its investment policy. Typically, this section refers to a financial market index or benchmark against which the fund's performance can be measured and which gives an indication as to the fund's investment universe. Clearly, index funds can be best described by simply stating the benchmark they replicate.

So far, benchmarks have found little attention by regulators. A benchmark is a collection of securities or risk factors and associated weights that represents the persistent and prominent investment characteristics of an asset category or manager’s investment process (CFA Institute). Benchmarks are an important tool for performance measurement and reporting, long advocated by various industry standards (AIMR-PPS, now GIPS). Using an appropriate benchmark and being transparent in reporting investment results is primarily a sign of sound industry practice and high ethical standards.

New Commission proposal

In the wake of the LIBOR scandal, regulators have become interested in financial indices used for measuring the value or determining the pay-out of different types of financial contracts. The Commission proposal (2013/0314 (COD), "BMR") aims at a common framework to ensure the accuracy and integrity of indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds. The Commission motivates the proposal by referring to the proper functioning of the internal market and consumer and investor protection.

BMR first introduces a new type of supervised entity, the "administrators", i.e. persons or legal entities having control over the provision of benchmarks. Administrators must fulfill a range of requirements regarding their organization, governance structure and personnel. They will have to seek authorization from or at least – if already supervised in another capacity deemed compatible with the provision of benchmarks – register with their national supervisor. ESMA is asked to maintain a public register with all administrators and benchmarks offered. Special provisions deal with critical or significant benchmarks – benchmarks against which a sizable amount of money is managed or linked to, reminiscence, maybe, to the FSB discussion on systemically important asset managers.

The requirement to use observable transaction data as input to calculating benchmarks provides an interesting link to the post-trade transparency regime from MiFID/MiFIR.

Impact on Switzerland

As in the case of other recent regulatory initiatives, there is an equivalence clause for administrators from third countries. Supervised entities located in the EU may use benchmarks offered by administrators outside the EU if they are included in the public register, which essentially requires an equivalent regulation of the benchmark topic in their home country.

The question seems particularly relevant to fund managers offering Swiss equity funds but domiciled in the EU (e. g Luxembourg or Dublin). While Switzerland is in the process of fundamentally overhauling its financial markets regulation, the topic of benchmarks has yet not been addressed in the relevant new legislation (FINIG, FIDLEG, FinfraG). The provision of benchmarks is not seen as a financial service requiring authorization.

Target audience

Issuers of structured products are potentially more heavily affected than the already highly regulated mutual fund companies. Still, they will have to add a new element to their compliance processes. Investors may feel more comfortable with their performance statements. They should (and most likely will) not feel relieved to ask the right questions when reviewing their managers' performance.