The EU Benchmarks Regulation covers a broad variety of benchmarks. It applies to all benchmarks that are used to reference financial instruments admitted to trading or traded on a regulated venue, such as energy and currency derivatives, those that are used in financial contracts, such as mortgages and those that are used to measure the performance of investment funds. The EU Benchmarks Regulation defines an index as a figure which is publicly available and is regularly determined, either by applying a formula to or making an assessment of a representative set of underlying data.
Benchmarks represent a wide range of underlying asset classes including equity, fixed income, commodity, FX, as well as alternative, non-financial interests. LIBOR, SONIA, FTSE100 and ICE Brent Index are just a few examples of a large number of benchmarks provided and used in the financial markets. The Regulation seeks to address possible shortcomings at every stage in the production and use of benchmarks.
The integrity of the benchmark administrator and the underlying data is of critical importance since for nearly all widely used indices some judgment or discretion needs to be exercised. For all benchmarks there is discretion - either at the input data or the administrator level and conflicts of interest exist. As such, the potential for manipulation exists in the same way as has been demonstrated in the cases of EURIBOR and LIBOR.
The Regulation has at its core four main objectives:
1. to enhance governance and controls over the benchmark process and in particular ensure that administrators avoid conflicts of interest, or at least manage them adequately;
2.to improve the quality of input data and methodologies, including the use of sufficient and accurate data;
3.to ensure that contributors to benchmarks are subject to adequate controls, in particular to avoid conflicts of interest and that their contributions to benchmarks are subject to adequate controls; and
4.to ensure adequate protection for investors and consumers through improved transparency and suitability assessments.
Critical benchmarks are supervised by colleges of supervisors, led by the supervisor of the benchmark administrator and including the European Securities and Markets Authority (ESMA). In cases of disagreement within the college, ESMA will be able to decide by binding mediation. Other additional requirements are imposed on critical benchmarks, including the power for the relevant competent authority to compel contributions.
Central banks that are members of the European System of Central Banks are exempted from its scope as they already have systems in place that ensure compliance with the objectives of the Regulation.
-Regulation (EU) 2016/1011 of the European Parliament and of the Council of 8 June 2016 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds and amending Directives 2008/48/EC and 2014/17/EU and Regulation (EU) No 596/2014)
The Regulation entered into application on 1 January 2018, with its final transitional period expiring on 1 January 2022 (for critical and third country benchmarks). It has since been amended by two targeted legislative initiatives in 2019 (ESAs review and Climate Benchmarks Regulation).
Several Delegated Acts were published between June 2017 and January 2018. The RTS necessary for fleshing out the detail of the Regulation were published in the Official Journal of the EU on 5 November 2018.
As part of a Commission initiative to facilitate investment in sustainable projects and assets across the European Union, new rules establishing and governing the provision of low carbon and positive carbon impact benchmarks were introduced in December 2019. Regulation (EU) 2019/2089 amending Regulation (EU) 2016/1011 as regards EU Climate Transition Benchmarks, EU Paris-aligned Benchmarks and sustainability-related disclosures for benchmarks (the Climate Benchmarks Regulation) introduces the ESG disclosure rules as well as harmonised minimum standards for low-carbon benchmarks across the Union. The Regulation also introduces further requirements for making the methodology of the new categories of benchmarks transparent, so as to make them more comparable and to enable better decision making by portfolio managers.
A further Regulation impacting the BMR has been published. Regulation (EU) 2019/2175 of the European Parliament and of the Council of 18 December 2019 (ESAs’ review) requires ESMA to develop five draft RTS to be submitted to the Commission by 1 October 2020. To that end, ESMA has published a consultation paper on a new set of RTS stemming from the ESAs’ review (Consultation Paper - Draft Regulatory Technical Standards under the Benchmarks Regulation (ESMA70-156-1464)).
Cases of manipulation of interest rate benchmarks such as LIBOR and, as well as allegations that energy, oil and foreign exchange benchmarks have been manipulated, have highlighted shortcomings in the benchmarks process. The actual cases and investigations underway have underlined the importance of benchmarks and their vulnerabilities, including conflicts of interest, weak governance and the lack of clarity about regulatory oversight. The integrity of benchmarks is critical to the pricing of many financial instruments, such as interest rate swaps and forward rate agreements, and commercial and non-commercial contracts, such as supply agreements, loans and mortgages. They also play an important role in risk management.
In September 2012 the European Commission launched a public consultation on a possible framework for the regulation of the process of benchmarks. This consultation sought to identify the key issues and shortcomings in production and use of benchmarks in order to assess the need for any necessary changes to the legal framework to ensure the future integrity of benchmarks.
-Consultation on a Possible Framework for the Regulation of the Production and Use of Indices serving as Benchmarks in Financial and other Contracts
In January 2013 ESMA and the EBA launched a three month consultation on the Principles for Benchmarks-Setting Processes in the EU. ESMA and the EBA identified significant weaknesses and insufficiencies in the governance of the Euribor rate-setting mechanism and made a number of recommendations to EEBF. The Principles were developed in response to concerns regarding the perceived weaknesses in current arrangements for benchmark rate-setting. They address the activities of reference-rate and other benchmark providers, administrators, publishers and market participants who submit data. The proposed Principles included a general framework for benchmarks settings (calculation methodology, governance, supervision, transparency of the methodology, contingency plans, etc.). They also provide guidance to firms involved in benchmark data submissions and to benchmark administrators, calculation agents, publishers and users.
-JC/CP/2013/01: Consultation on Principles for Benchmarks-Setting Processes in the EU
In the UK several measures have been undertaken in response to the LIBOR and EURIBOR controversies. The Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2013 has introduced new regulated activities for firms administering a specified benchmark (currently only applies to LIBOR) and for firms providing information in order to determine a specified benchmark. Also the expansion of the market abuse regime to include misleading statements and impressions relating to benchmarks by virtue of the Financial Services Act 2012 (Misleading Statements and Impressions) Order 2013.
In July 2013 the International Organisation Securities Commissions (IOSCO) agreed principles on benchmarks which are to be implemented by its members. The Principles for Financial Benchmarks provides an overarching framework of principles for benchmarks used in financial markets. In addition to a set of high level principles, the framework offers a subset of more detailed principles for benchmarks having specific risks arising from their reliance on submissions and/or their ownership structure. The principles provide for benchmark administrators to publicly disclose their compliance with the principles within twelve months of the publication of the report, with the intention of IOSCO reviewing within an 18 month period the extent to which the principles have been implemented. The European Commission participated actively in the IOSCO task force drafting the principles.
-Principles for Financial Benchmarks - Final Report
Existing provisions in other legislation
Articles 2(3)(d) and 8(1)(d) of MAR and the Market Abuse Directive (CSMAD) clarify that any manipulation of benchmarks is clearly and unequivocally illegal and subject to administrative or criminal sanctions.
The Regulation on Energy Market Integrity and Transparency (REMIT) provides that the manipulation of benchmarks that are used for wholesale energy products is illegal.
MiFID requires that any financial instruments admitted to trading on a regulated market are capable of being traded in a fair, orderly and efficient manner and its Implementing Regulation further specifies that the price or other value measure of the underlying must be reliable and publicly available.
Article 30 of MiFIR contains a provision requiring the non-exclusive Licencing of benchmarks for clearing and trading purposes.
The Prospectus Directive (PD) and its Implementing Regulation provide that where a prospectus contains a reference to an index, the issuer should set out the type of the underlying and details of where information on the underlying can be obtained, an indication of where information about the past and the further performance of the underlying and its volatility can be obtained, and the name of the index.
The UCITS Directive provides that UCITS funds may only hold a maximum share of instruments issued by the same body in their portfolio. Member States may raise the limits that apply to how much of its total portfolio a UCITS may hold to a maximum of 20% for investment in shares or debt securities issued by the same body when it concerns an index which the UCITS wants to replicate, provided the composition of the index is sufficiently diversified, the index represents an adequate benchmark for the market to which it refers and it is published in an appropriate manner.