Financial Benchmarks

All published benchmarks that are used as a reference for a traded financial instrument or contract will have to comply with strict new rules under a recently presented legislative proposal.

The Commission’s aim is to restore market confidence in financial benchmarks following the discovery in 2012 that some banks had been altering their data in order to manipulate the London Interbank Offered Rate (LIBOR) and the Euro Interbank Offered Rate (EURIBOR).  

Scope

The proposal sets out a common legal framework for all published financial benchmarks, ranging from energy and currency derivatives to financial contracts like mortgages. Indeed, though the Commission accepts that financial benchmarking can be by its nature discretionary, it is very specific that the regulation should cover all benchmarks, in order to avoid any risk of manipulation or consumer confusion.

Governance

First and foremost, the proposal aims to ensure that conflicts of interest are avoided and that controls are effective. This means that the entity in control over the provision of a benchmark would be subject to a number of governance requirements. These include: 
• A clear organisational structure 
• Oversight of the provision of its benchmark
• A control framework to ensure adequate provision and publication of the benchmark
• An accountability framework covering record keeping, auditing and complaints

Administrators - such as financial institutions - would not be able to outsource the provision of a benchmark if that would impair the administrator’s control or the ability of authorities to supervise the benchmark.

Methodology

The proposal lays down rules on the data to be used for the calculation of benchmarks, as well as on the methodology for this calculation. This data must be sufficient to represent accurately and reliably the economic reality it intends to measure, and be obtained from a reliable and representative sources.

The benchmark data and the methodology should also be developed, operated and administered transparently. The administrator must notify the authorities of any conduct involving manipulation of attempted manipulation of a benchmark.

Code of Conduct

Administrator would adopt a code of conduct for each benchmark, specifying the administrators' and contributors' responsibilities and obligations. Input data must not be affected by existing or potential conflicts of interest, and there should be a control framework to ensure integrity, accuracy and reliability.

Critical Benchmarks

The proposal also lays down specific requirements for inter-bank interest rate benchmarks (Annex II) and for commodity benchmarks (Annex III). It also sets additional requirements for critical benchmarks, which are defined as financial instruments having a notional value of at least €500 billion.

Consumer Protection

Administrators would be required to provide a statement setting out what the benchmark measures. This would include:
• The economic reality measured by the benchmark
• A list of the purposes for which the benchmark could be used
• Technical specifications 
• Notice of the possibility that other factors may affect the benchmark
• Warning that any financial contract that references the benchmark should address the possibility of changes to the benchmark

Administrators should make public the input data used to determine the benchmark right after the publication of the benchmark, except when the publication might have adverse effects on the reliability or integrity of the benchmark. In these cases the publication would be delayed.

An administrator should publish a procedure with the actions to be taken in the event of changes to a benchmark. Supervised entities dealing with financial instruments or contracts that reference a benchmark should also produce plans setting out the actions to take in such an event.

Supervised entities should also assess a consumer’s knowledge of a benchmark before getting into a financial contract with them, and assess if the benchmark is suitable for them.

Authorisation Procedure

Benchmarks provided by administrators established in a third country can be used by supervised entities, provided the administrator notifies the European Securities and Markets Authority (ESMA) of its consent for the use of its benchmark by supervised entities in the EU.

Administrators that provide indices covered by the proposal would need to obtain prior authorisation by the competent authority of the Member State in which the administrator is located. The ESMA would keep a register of authorised administrators.  An authorised administrator would need to comply at all times with the conditions for the authorisation.

Supervision

Each Member State would designate a relevant competent authority to carry out supervisory and investigatory tasks, and would empower them to impose administrative sanctions. Decisions imposing sanctions should be published. Competent authorities would cooperate and assist other competent authorities in order to develop on-site inspections and investigations.

Competent authorities would notify ESMA of the use of an index in a financial instrument. Information received from another competent authority could be disclosed only if there is an agreement of that competent authority to do so, and if that disclosure is necessary for legal proceedings.

For critical benchmarks, colleges of competent authorities for supervision would be formed, which would include the competent authority of the administrator, ESMA and the competent authorities of the contributors.

Next Steps

The proposal will now be sent to the European Parliament and the Council for examination.

The Commission would be obliged to review and report to the European Parliament and the Council on this Regulation by July 2018.