By: Conor Foley & Anna Sedzik.
This memo summarises key provisions of the draft proposal for a Regulation of the European Parliament and of the Council on indices used as benchmarks (IBR) and next steps in the legislative review process.1
1. Key point summary
(1) If adopted, the proposed legislation would apply to all benchmarks that are used to reference – (a) a financial instrument admitted to trading or traded on a trading venue, (b) a “financial contract” or (c) to measure the performance of an investment fund. The proposal includes specific provisions on interest rate benchmarks and commodity price assessments (“commodity benchmarks”).
(2) Benchmark “administrators”, including PRAs, would be subject to an authorisation obligation and supervision by their national competent authority. This would apply to all categories of benchmarks, including “critical benchmarks”, prospectively including LIBOR and EURIBOR.
(3) The proposed legislation would permit the use of non-transaction data for benchmarks, albeit in very limited circumstances. Contributors would be obliged to comply with a binding “code of conduct” established by benchmark administrators and with specific provisions on governance and controls.
(4) Competent authorities would be empowered to compel a contributor to a “critical benchmark” to provide information for benchmark setting. The “Critical benchmark” category can potentially encompass all types of benchmarks.
(5) The proposed legislation introduces a separate regime for the use of benchmarks provided by administrators established outside the EU. Such benchmarks would be eligible for use in the EU subject to specific conditions, including adoption of an equivalence decision by the Commission.
(6) Competent authorities would be given broad supervisory and investigatory powers, including the application of sanctions on benchmark administrators and contributors, on-site inspections, access to and seizure of documents and data, and the ability to suspend trading of a financial instrument using a benchmark. Of note – the proposal would allow the competent authorities in the case of commodity benchmarks to “have direct access to traders’ systems”.
(7) ESMA would not have direct supervisory powers over any category of benchmarks. It would participate in the colleges of competent authorities for critical benchmarks and provide binding mediation in the case of disagreements between national competent authorities.
2. Main provisions of the Commission’s proposal
The proposed Regulation follows a number of legislative and non-legislative activities on both European and international level that sought to address various elements of benchmark setting process. Most recently, the European legislators approved new the Market Abuse Regulation (MAR) that introduces liability for benchmark manipulation.2Amendments to Market Abuse Directive (MAD) introducing criminal sanctions for benchmark manipulation are pending final adoption. Earlier this year, ESMA published non-binding Principles for Benchmark Setting Processes in the EU.3At international level, the Commission’s proposal follows IOSCO’s Principles for Financial Benchmarks and 2012 IOSCO Principles for Oil Price Reporting Agencies (PRAs).
The proposed legislation will now be transmitted to the European Parliament and to the EU’s Council of Ministers (Member States) for review in accordance with ordinary legislative procedure. Both legislators will be able to introduce amendments to the proposed text.
Key provisions of the proposal are summarised below –
(1) Scope and definitions (Article 2 – 4)
Article 2 IBR sets out the scope of the proposal to cover “the provision of benchmarks, the contribution of input data to benchmarks and the use of benchmarks” in the EU. The Commission defines an “index” as any figure that – (a) is published or made available to the public, (b) is regularly determined by the application of a formula or assessment, (c) this determination is based on the value of underlying assets, prices or other values. This is combined with the definition of a “benchmark”, which is described as “any index by reference to which the amount payable under a financial instrument or a financial contract, or the value of financial instruments is determined or is used to measure the performance of an investment fund”. The definition of a benchmark differs from that included in MAR or MiFIR legislative proposal.4
The benchmark definition stipulates that the proposal would apply to all benchmarks that are used to reference financial instruments admitted to trading or traded on a trading venue, including financial and commodity derivatives. It would also apply to certain consumer credit and mortgage agreements (Article 3 IBR). Application to purely OTC contracts remains unclear.
The proposed legislation also distinguishes categories of “contributor”, “supervised contributor” and “supervised entities”. The latter would include banks, investment firms, insurance and reinsurance undertakings, UCITS, AIFMs, CCPs, trade repositories and a benchmark administrator (Article 3 IBR).
Annex II and III of the proposal outlines specific provisions for interest rate and commodity benchmarks respectively. Commission would be able to amend the particular elements of Annex II and III.
(2) Authorisation of benchmark administrators (Articles 22-24)
In accordance with Article 22 IBR, an administrator of an index would have to obtain an authorisation from a competent authority to provide a benchmark, if the relevant index is used or “intended to be used” as a benchmark. Administrators currently providing benchmarks would have to apply for authorisation within two years from the entry into force of the proposed regulation (Article 39). Of note – administrators of benchmarks who are not aware or “could not reasonably have been aware” that their benchmarks are used in a way that meets the definition of a benchmarks as set out in Article 3 IBR, would be exempted.
For all benchmarks in scope of the proposal the national competent authority of the jurisdiction in which the administrator is located will be considered the competent authority (Article 23 IBR). This is a significant change in comparison to early unofficial draft of the Commission proposal, which suggested transferring responsibility for certain categories of benchmarks to ESMA. All benchmark administrators would have to comply with specific governance and control requirements set out in Annex I of the proposal, including internal and external audit. Competent authorities will be able to withdraw the authorisation for a benchmark administrator (Article 24 IBR).
(3) Regulation of the use of third country benchmarks in the EU (Articles 19-21)
If adopted, the proposed regulation would introduce a separate regime for the use of third country benchmarks in the EU. Benchmarks provided by an administrator located in a third country would be eligible for use by an EU-based “supervised entity” only if such an administrator is registered with ESMA. Registration with ESMA will be conditional on several factors, including the adoption by the Commission of a decision determining that a given third country’s legal framework and “supervisory practice” is equivalent to the requirements of the proposed Regulation (Article 20 IBR). ESMA will be able to withdraw registration for a third country benchmark administrator (Article 21 IBR).
(4) Eligible data and obligation to report to “critical benchmarks” (Articles 7-14)
If adopted, the proposed Regulation would seek to limit the ability of benchmark administrators to use non-transaction data. The use of non-transaction data for the calculation of benchmarks would be permitted only if the available transaction data would not be sufficient to “represent accurately and reliably” the relevant market (Article 7 IBR). Non-transaction data would have to be “verifiable”. Administrators would have to obtain data from “representative contributors”, considered as “reliable and representative panel or sample of contributors”. Administrators would be obliged to verify the non-transaction data when a single contributor is a party to more than 50% of value of transactions in a given market.
Administrators would be obliged to create a binding code of conduct for each benchmark, specifying the responsibilities of both administrators and contributors (Article 9 IBR). The Commission would be able to further specify the terms of the relevant code of conducts. “Supervised contributors”, i.e. supervised entity that would contribute to a benchmark operated by an EU-based administrator, would have to comply with the specific governance and controls provisions (Article 11 IBR). This would include having effective policies governing potential conflicts of interests and disclosure obligation in place vis-à-vis competent authorities.
If adopted the proposed Regulation would empower competent authorities to compel the provision of data to “critical benchmarks” (Article 13 IBR). “Critical benchmarks” are defined as benchmarks, to which the majority of contributors are “supervised entities” and which are used as a reference for financial instruments having a notional value of at least EUR € 500 billion (Article 3(21) IBR). Note that the draft proposal does not specify whether those conditions refer to Member State or EU-28 level. The competent authority would be able to request a mandatory contribution when a minimum 20% of contributors have ceased or is likely to cease contributing to a “critical benchmark” on annual basis (Article 14 IBR).
(5) Powers of competent authorities and ESMA (Articles 31-34)
Article 30 IBR would equip relevant competent authorities with extensive supervisory and investigatory powers. This would include access to documents, data and information, on-site inspections, entry to premises and seizure of documents, access to data traffic records (recordings of telephone conversation, e-mails and other), freezing and/or sequestration of assets. This would also include the suspension of trading of a financial instrument which references a benchmark. For the purpose of commodity benchmarks, competent authorities would be allowed to request information from spot market participants, receive transaction reports and “direct access to trader’s systems”.
Competent authorities will also be allowed to set administrative measures and sanctions for breaches of the proposed Regulation (Article 31 IBR). This would vary from an issuance of a public warning or cease and desist orders, to imposition of financial penalties. The latter could amount to – (a) minimum three times the amount of the profits gained or losses avoided because of the breach, (b) between EUR € 500,000- EUR € 700,000 for a natural person, and (c) between EUR € 250,000 or 2% annual turnover and EUR €1,000,000 or 10% annual turnover for legal persons. A decision imposing administrative measures or sanctions should be published (Article 33 IBR).
Contrary to the previous unofficial draft of the Commission’s proposal, ESMA competences have been substantially scaled down. ESMA will not exercise direct supervision over any category of benchmarks. It would participate in the colleges of competent authorities for “critical benchmarks”, where it would help to coordinate activities of national competent authorities. It would also be able to provide a binding mediation in the case of a disagreement between the colleges (Article 34 IBR).
3. Next steps
The proposal will now be sent to the Council of Ministers (Member States) and the European Parliament for review and adoption. The Lithuanian Presidency of the Council (Q3 – Q4 2013) will lead the initial phase of the Council review. It is not expected to advance the legislative review substantially, given the ongoing trilogue negotiations on MiFID 2 / MiFIR proposals which are likely to take precedence. The legislative review is expected to continue under the Greek Presidency (Q1-Q2 2014). The upcoming Presidency has already indicated its plan to focus on the outstanding banking and MiFID legislation. Legislative review is expected to be finalised in Q4 2014 / Q1 2015.
In the European Parliament the Economic and Monetary Affairs (ECON) committee will lead the legislature’s review of the proposal. The coordinators of the political groups will decide in the coming weeks which group is allocated the lead on the proposal. Since the outbreak of the LIBOR scandal in July 2012, an increasing number of legislators have demonstrated interest in the functioning of indices and benchmarks. This includes in particular Arlene McCarthy (S&D, UK), Wolf Klinz (ALDE, DE), Nuno Melo (EPP, PT), Werner Langen (EPP, DE) Ramon Tremosa i Balcells (ALDE, ES), Sven Giegold (Greens, DE) and Kay Swinburne (ECR, UK). The rapporteur is expected to be appointed in the next coordinators meeting on 08 October.
Adoption of the legislative act in the first reading agreement usually takes 14-16 months. However, given the busy legislative and regulatory agenda and the European election calendar, it is unlikely that the final adoption would take place before the May 2014 elections in the European Parliament and the appointment of the new College of Commissioners in the autumn. Nevertheless, this tight institutional schedule may prompt an attempt by some legislators to rush the proposal through, which would present risks for index and benchmark providers, PRAs and other market participants.
Questions and comments:
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1 European Commission – Proposal for a Regulation of the European Parliament and of the Council in indices used as benchmarks in financial instruments and financial contracts [COM(2013) 641/3], 18.09.2013.
2 European Parliament legislative resolution of 10 September 2013 on the proposal for a regulation of the European Parliament and of the Council on insider dealing and market manipulation (market abuse) (COM(2011)0651 – C7-0360/2011) [MAR].
3 Final Report – ESMA / EBA Principles for Benchmark-Setting Processes in the EU [2013/658], 06.06.2013.
4 See Article 5(2) MAR and Article 2(1)24 of European Commission Proposal for a Regulation of the European Parliament and of the Council on markets in financial instruments and amending