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The EU Benchmark Regulation (“EU BMR”) became effective on 1 January 2018 and seeks to increase the robustness and reliability of financial benchmarks and protect them from the type of manipulation that occurred during the financial crisis. Whilst the regulation was effective from 1 January 2018, the text includes transitional arrangements for existing EU and third country benchmark administrators, allowing these administrators to apply for authorisation any time before 1 January 2020.
On 26 February 2019, the European Council and Parliament reached a political agreement to amend EU BMR to extend the transitional provisions for critical and third country benchmarks for a further two years to comply and undertake the requirements in the regulation.
This blog explores why an extension to the transitional arrangements was agreed, what has changed, the impact of the extension and what benchmark administrators, contributors and users should be doing now.
There is a question of whether the published list of critical benchmarks will be updated before the end of 2019 with further critical benchmarks that might be identified. EU administrators that think they administer a critical benchmark should immediately consult with their local EU competent authority.
The ECB Working Group has indicated its preference for EONIA to be modified to €STR plus a spread for a limited period (expected by the end of 2021) which could be implemented by October 20197
Given the extended transitional period, firms should incorporate EONIA transition, and other IBORs which are potentially transitioning to alternative risk free rates to their wider programmes around IBOR reform.
The practical application of the third country requirements for administrators needs careful, and focused consideration, given the lack of third country administrators on the ESMA register at present. Arguably, the future success of the Regulation could be measured in part, by the level of adherence to it by those administrators from outside of the EU.
For equivalence, there is a need for increased clarity on the European Commission’s timeline for making a decision so that firms can initiate alternative plans if an equivalence decision will not be made in time. It should be noted that the Commission has recently published draft equivalence decisions for Australia8 and Singapore9 for a small number of benchmarks administered in these jurisdictions.
For firms looking to apply for recognition, transparency on how third country firms can find and use appropriate market data (such as the FIRDs database) to identify the member state of reference is required. Additionally, firms have raised concerns over how to establish legal liabilities between the third country administrators and the EU legal representative or endorser and whether to wait to apply directly to ESMA.
Firms have indicated confusion on whether NCAs will recognise the IOSCO Principles10 as being stringent to the requirements of EU BMR to assess compliance to the regulation. It may be expected that for endorsement, an external assurance report of compliance to IOSCO will be needed for the endorser to assess compliance, increasing compliance costs for firms. Indeed, the important role that third party independent assurance can provide also needs clarification.
Third country administrators should be aware of the review of powers for European Supervisory Authorities11 . A political agreement has been achieved between the EU Commission and Parliament12 where third country administrators and their legal representative would be supervised by ESMA and need to apply to ESMA directly for recognition rather than the relevant EU NCA.
In light of these concerns, the European Commission will submit a report to Parliament and the Council on the operation of the third country regime by April 2020, its implementation in practice and its shortcomings. This will include an assessment of whether the third country regime requires amending. Firms are encouraged to engage with industry bodies and the Commission to ensure industry concerns are raised.
With uncertainty around the UK’s exit from the European Union, which is expected to happen during the extended transitional period for EU BMR, the UK Government issued an explanatory information document to the Benchmark Regulation in January 201913 . This provided some clarification on the impact of Brexit for administrators, including the designation of the FCA as the sole regulator for UK BMR.
Third country firms applying for recognition to the UK and EU will need to apply twice and will need to have legal representation in each jurisdiction, further increasing compliance costs. Third country firms included on the ESMA register on Brexit day will have an additional 24-month period to apply to the FCA.
Concerns around conflict of interest around equity-linked indexes have led for calls within the US for a review of benchmark administration14 , conflict of interest and potential manipulation of benchmarks as there is no US regulation of financial benchmarks. The CFTC, in October 2018 established a new subcommittee for interest rate benchmark reform within its Market Risk Advisory Committee and their mandate does cover regulating use of benchmarks. Firms should be aware of any developments or reviews that could result in legislation over use of financial benchmarks, including administrators.
The extension to the transitional arrangements for critical and third country benchmarks has moved the timeline but, as yet, has not altered the requirements that administrators, contributors and users have to comply with. Firms should use this time wisely, in raising awareness and making plans to help ensure compliance well in advance of 2022.
The extension also provides the regulation the time and platform to engage with the industry and allow the market to get behind it. This time allows EU regulators time to clarify some of the requirements and aligns timing with wider reforms of interest rate benchmarks.
With the extension, awareness of the regulation and its implications is key to ensure that firms are aware and assess the viability of the three options available. Firms should consider how to drive advocacy and engage with regulators and industry bodies to ensure any concerns on the practicability of the third country regime are considered; especially with the review of the regulation by the EC in the next year. Firm plans on the BMR should consider the impact that Brexit will have, such as identifying another legal representative.
Firms using benchmarks should, with immediate priority, review their benchmark inventory and identify which benchmarks: are EU-based; have not been approved for use; and engage with administrators to understand whether they will be able to comply in time.
Users are encouraged to ask critical and third country administrators of their plans to comply with the regulation, regardless of the extension.
Firms should engage with administrators of these benchmarks and assess the likeliness that they will comply with the regulation in time and whether alternative benchmarks or contingency plans need to be activated.
The extension allows firms to incorporate compliance to the regulation for critical and third country benchmarks to their IBOR transition programmes and allows firms to appropriately plan for the transition of benchmarks such as EONIA to suitable alternative risk free rates alongside LIBOR.
Firms that contribute to benchmarks currently not on the register should engage with administrators to understand whether the benchmarks will be approved for use in 2019 or the benchmarks qualify for the extension. Contributors are encouraged to pro-actively be involved in the development of any Code of Conduct to ensure there is no ‘hidden-surprises’.
Stephen is a Partner in our Banking & Capital Markets Audit and Assurance Group and has a leadership role in the Firm’s financial benchmark assurance and advisory engagements. He has extensive experience in financial services audit, internal audit, and regulatory projects. He has worked with a range of banking institutions, having developed a thorough technical understanding of banking products and treasury control practices. He sits on a committee of the FICC Markets Standards Board, the Bank of England SONIA Sub Working Group focusing on Communications & Outreach, and Co-Chairs the Deloitte Global LIBOR Transition Steering Committee.
Mark is a Partner in our Banking & Capital Markets Audit Group in London. He is a leading member of our Benchmarks Assurance & Advisory team and a co-Chair of Deloitte’s Global IBOR Reform Steering Committee. Mark has 16 years’ experience across financial services audit and assurance, regulatory compliance, regulatory investigations and financial services disputes. This experience has provided him with a strong technical understanding of wholesale markets, financial benchmarks and related risk and control frameworks. His experience across the industry with respect to IBOR reform has provided him with a unique perspective on the regulatory reform agenda and he is actively assisting clients in this space at present.
Rickesh is a Senior Manager in our Banking & Capital Markets Audit Group in London and leads our Benchmark Advisory and Assurance work in the UK. Rickesh has extensive experience working with large multi-national financial institutions focussed on financial benchmark reform such as LIBOR, front to back controls frameworks and implementation, market abuse regulations, IOSCO principles for financial benchmarks and compliance with EU Benchmark Regulation.