The individuals and entities responsible for setting financial market reference rates or, more broadly, financial benchmarks, have not historically been subject to extensive regulation. Recent misconduct by banks with regard to the setting of interest rate benchmarks – along with the growing theme of greater oversight of the financial industry – has prompted regulators either to put in place regulation of interest rate benchmarks or to create the foundations for new regulation.
Various overlapping initiatives are now underway – at a national, European and international level – to regulate benchmarks more generally. This article focuses on three of the key proposals.
The International Organisation of Securities Commissions (IOSCO) is an association of world financial regulators. While IOSCO does not produce binding rules, it does seek to promote common standards of regulation and cooperation among regulators.
IOSCO published its “Principles for Financial Benchmarks” (Principles) in July 2013. As IOSCO has no rule-making powers, the Principles are recommended practices to be implemented by benchmark administrators (i.e., entities responsible for setting benchmarks) and submitters (i.e., persons submitting information to the administrators) worldwide. The Principles introduce a form of “comply or explain” obligation, as benchmark administrators are required to make a public announcement in July 2014 explaining how well they are complying with the Principles. This is an unusual request from a regulator that has typically provided high-level frameworks, rather than mandated specific actions, and there is some question as to the degree to which this obligation will be honoured, not least because IOSCO cannot impose any sanctions for non-compliance.
The Principles define a benchmark broadly, and include any index or rate calculated by reference to the value of underlying financial instruments or used to determine the sums due under a financial contract or the performance or value of a financial instrument. The Principles include a detailed code of practice for benchmark administrators, dealing with, inter alia, conflicts of interest and transparency.
In European terms, there has been more focus on the European Commission’s draft regulation on financial benchmarks.
The European Commission (Commission) is the executive body of the European Union, with responsibility for proposing EU-wide legislation. The Commission published a draft regulation on benchmarks in September 2013. That regulation has been through one subsequent draft, and will be further refined and shaped as it passes through the European legislative process. As such, the final scope and timing of the regulation is uncertain. What is clear from the initial draft, however, is that the Commission intends to propose:
- a new regime for the regulatory authorisation and supervision of benchmark administrators;
- a detailed code of conduct addressing, inter alia, conflicts of interest; and
- a requirement to disclose the underlying methodology and data used in determining the benchmark (except where doing so would have “serious adverse consequences” for the contributors or the benchmark).
The Commission has also proposed that any “supervised entity” (including MiFID investment managers and European AIFMs) may only use a benchmark provided by an authorised administrator or an administrator in a “third country” (i.e., outside the EU) if the Commission has determined that the relevant third country has “equivalent” supervision and regulation. Unsurprisingly, the “equivalence” concept triggered substantial comments – it has caused similar debate when used in other recent European legislative proposals.
The scope of the regulation is extremely broad, capturing all manner of public and private benchmarks. The requirement that supervision and regulation in a third country must be equivalent before any benchmark from that country can be used in the EU seems unworkable, given that the regulation of benchmarks is relatively novel (and that there is consequently little time for other jurisdictions to develop an "equivalent" regulatory regime).
A new draft of the regulation published by the European Parliament’s Committee on Economic and Monetary Affairs (ECON) on 20 November 2013 contained some amendments to narrow the scope of the regulation, and also addressed the position of third-country index providers. This draft limited the scope to various defined categories of benchmarks, including “broadly used commodity benchmarks” and “benchmarks that reference the price of a financial instrument in substantial use in retail markets”, and confirmed that compliance with the Principles is sufficient for a third-country administrator to be deemed as equivalent with the proposed regulation.
One interesting perspective on the regulation is provided by the UK government in an opinion that it submitted to the Commission on 6 December 2013. Basing its argument on the principle of subsidiarity – namely, that action at EU level should “add value” and be undertaken only where the objectives cannot be delivered at national level – the UK government attacked the breadth of the proposal and argued that intervention at national level was a more appropriate means of addressing the problems associated with specific benchmarks. A clear case in point from the UK’s perspective are the steps being taken in the UK to regulate the production of, and criminalise manipulation of, LIBOR (the interest rate at which banks lend to each other in the London market). The UK’s view is that the Commission’s proposal to regulate, with a single set of detailed rules, such a varied universe of benchmarks is potentially harmful and burdensome on benchmark administrators and users.
The regulation will work its way through the European legislative process. In its current form, it is an ambitious and uncertain proposal.
Lastly, the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) published a final report on principles for benchmark-setting processes in the EU in June 2013. These principles were presented as interim measures to help in the transition to any future legal framework. They are not directly binding, but local regulatory authorities (such as the UK’s Financial Conduct Authority) are required to adopt the principles into local law, or justify any alternative approach. The principles contain similar best practices for benchmark submitters and calculation agents as in the Commission’s draft regulation. As yet, the Financial Conduct Authority has not indicated whether or to what extent it will adopt these principles.
Given recent events, it is no surprise that benchmarks are coming under increased regulatory scrutiny. While the market protection argument is easy to understand, it is also clear that benchmarks can be incredibly complex, and there is unlikely to be an acceptable one-size-fits-all approach to successfully regulating their use and accuracy. ECON's revisions to the Commission’s proposed regulation appear to accept this, and are therefore to be welcomed. It is early days, however, and will be some time until we are at “on your marks”.