The European Union Benchmarks Regulation (‘BMR’)
The BMR regulates indices used as benchmarks in financial instruments and financial contracts (and/or to measure the performance of investment funds) and entered into force… Read more
The BMR regulates indices used as benchmarks in financial instruments and financial contracts (and/or to measure the performance of investment funds) and entered into force on 30 June 2016 – most of the provisions came into effect on 1 January 2018.
The regulation introduces a common framework and consistent approach to benchmark regulation across the EU. It aims to ensure benchmarks are robust and reliable, and to minimise conflicts of interest in benchmark-setting processes.
What is an index?
The BMR defines an index as a figure that is publicly available and is regularly determined, either by applying a formula or other calculation or making an assessment on the basis of the value of one or more underlying assets/prices (including estimated prices, actual or estimated interest rates, quotes and committed quotes, or other values or surveys).
An index becomes a benchmark within the scope of the BMR where:
- it is used to determine the amount payable under a financial instrument or financial contract, or the value of a financial instrument; and/or
- it is used to measure the performance of an investment fund for the purpose of:
- tracking the return;
- defining the asset allocation of a portfolio, or
- computing the performance fees.
The statutory framework
As the national competent authority under the BMR, the Financial Conduct Authority (‘FCA’) has powers to regulate certain activities in relation to benchmarks that are specified by HM Treasury.
The relevant regulatory permissions concerning benchmarks are:
- administering a specified benchmark;
- providing information in relation to a specified benchmark; and
- the more general permission of agreeing to carry on either regulated activity.
Currently there are eight benchmarks issued by benchmark administrators – the most commonly used benchmark is LIBOR (‘London Interbank Offered Rate’). The FCA also regulates individuals contributing to LIBOR (the other seven benchmarks are not based on contributions). The other seven benchmarks are: ICE Swap Rate, Sterling Overnight Index Average, Repurchase Overnight Index Average, VM/Reuters London 4 p.m. Closing Spot Rate, LBMA Gold Price, LBMA Silver Price and the ICE Brent Index.
An approved person performing the controlled function of benchmark submission needs to be ‘fit and proper’ for regulatory purposes and is subject to FCA supervision and enforcement, if applicable. Further, while firms (and individuals within firms) may not be administering a specified benchmark or providing information in relation to such a benchmark, they may be ‘benchmark users’ and could be caught by the new requirements in any case.
For example, a firm could be ‘using’ a benchmark if it determines the amount payable under consumer credit agreements by reference to an index and/or issues (or are party to) a financial instrument that references an index. This ‘usage’ is discussed further, below.
It is worth noting that under the upcoming extension to the FCA’s Senior Managers and Certification Regime, a similar approval may need to be held by a senior manager in respect of benchmark activities.
The BMR in brief
As noted above, the principal objectives of the BMR are to restore investor and consumer confidence in the accuracy, robustness and integrity of indices used as benchmarks, after index manipulation episodes including LIBOR and FX.
- The BMR groups benchmarks into six different types:
- Critical benchmarks: the value of contracts underlying the benchmark is at least €500bn, or where a benchmark has been recognised as critical in an EU Member State. LIBOR has been denoted under the BMR as ‘critical’.
- Significant benchmarks: the value of contracts underlying the benchmark is at least €50bn, or where there are no or very few market-led substitutes and there would be an impact on financial stability if the benchmark ceased to be produced.
- Commodity benchmarks: the underlying asset of the benchmark is a commodity, as defined by the Markets in Financial Instruments Directive II (commonly known as ‘MiFID II’). Broadly, commodity benchmarks are subject to the requirements set out in Annex II of the BMR (unless they are regulated data benchmarks, below).
- Regulated data benchmarks: input data to the benchmark is provided directly from regulated venues. Certain provisions of the regulation do not apply to regulated data benchmarks, and they cannot be classified as ‘critical’.
- Interest rate benchmarks: the benchmark is determined based on the rate at which banks may lend to, or borrow from, other banks or agents in the money markets. Interest rate benchmarks are subject to the requirements set out in Annex I of the BMR.
- Non-significant benchmarks: the value of contracts underlying the benchmark is less than €50bn, and the benchmark is not a ‘commodity’ or ‘interest rate’ benchmark.
Practical implications for firms
Broadly there are three categories of ‘users’ affected by the BMR, specifically benchmark: administrators, contributors and users.
Under the BMR, the definition of ‘provision of a benchmark’ comprises three activities:
- administering the arrangements for determining a benchmark.
- collecting, analysing or processing input data for the purpose of determining a benchmark.
- determining a benchmark through the application of a formula or other method of calculation or by an assessment of input data provided for that purpose
A ‘contributor’ is defined as a natural or legal person contributing input data. It follows that this input data is used by the administrator to calculate a benchmark.
There are certain compliance and governance provisions in the BMR that apply to contributors. Unlike benchmark administrators, the BMR does not require benchmark contributors to apply for authorisation or registration.
While the BMR does not define ‘benchmark user’, ‘use of a benchmark’ is defined in a number of ways – for example, issuing a financial instrument that references an index or a combination of indices. Firms should take a cautious approach: it may not always be obvious that they are ‘benchmark users’, and analysis will need to be undertaken to ensure compliance with the BMR as appropriate.
More on LIBOR
LIBOR is a benchmark rate produced for five currencies (the U.S. dollar (‘USD’), euro (‘EUR’), pound sterling (‘GBP’), Japanese yen (‘JPY’), and Swiss franc (‘CHF’); with seven maturities quoted for each.
These maturities range from overnight to 12 months, producing 35 rates each business day, based on submissions from a reference panel of between 11 and 16 banks for each currency.
The benchmark rate provides an indication of the average rate at which a LIBOR contributor bank can obtain unsecured funding in the London interbank market for a given period, in a given currency.
Previously, LIBOR was formally known as ‘bba LIBOR’ given it was administered by the British Bankers’ Association (the BBA is now called UK Finance). NYSE Euronext took over the administration of LIBOR from the BBA in 2013/14 and, having taken over NYSE Euronext, Intercontinental Exchange Group became the new administrators in early 2014.
In the aftermath of the global financial crisis, concerns developed about the effectiveness, accuracy and overall operation of LIBOR and other benchmarks. Further, regulatory investigations (by UK, EU and international authorities) found that attempts were made to manipulate LIBOR and other benchmarks.
A LIBOR-ious change?
In light of the problems with LIBOR, in a speech on 27 July 2017, the FCA’s CEO, Andrew Bailey, announced that LIBOR would be supported for a further five years, to the end of 2021. After this time, a transition will be made to alternative rates.
He said: “We do not think we will complete the journey to transaction-based benchmarks if markets continue to rely on LIBOR in its current form. And while we have given our full support to encouraging panel banks to continue to contribute and maintaining LIBOR over recent years, we do not think markets can rely on LIBOR continuing to be available indefinitely.”
In November 2017, the FCA has confirmed that all panel banks have agreed to support the LIBOR benchmark ensuring the sustainability of the rate until 2021.
On 19 September 2018, the FCA and PRA wrote to CEOs of major banks and insurers supervised in the UK asking for the preparations and actions they are taking to manage transition from LIBOR to alternative interest rate benchmarks – what it calls a “collective effort”.
The purpose of the letter has been to seek assurance that firms’ senior managers and Boards understand the risks associated with this transition, and are taking appropriate action now so that firms can transition to alternative rates ahead of the 2021 deadline. Market participants should review and consider the references to LIBOR in loan agreements being entered into now and extending beyond 2021 – as part of its ongoing compliance with the BMR today.
Prior to 1 January 2018, certain mandatory administration and contribution provisions applied in respect of critical benchmarks, as well as provisions concerning market abuse.