The EU Benchmark Regulation entered into force on June 30, 2016, and addresses the substantially complex area of benchmarks within EU financial regulation.
A benchmark is an index determined from a set of underlying data which is used to establish the value or amount payable under certain financial instruments or contracts, or to measure the performance of investment funds. Benchmarks covered by the Regulation include indices relating to financial instruments admitted to trading (as defined in the MiFID directive), interbank rates, commodities, mortgages and currency indices.
The difference in methodologies used in the provision of benchmarks has exposed a susceptibility to manipulation and abuse, particularly where the bodies determining the benchmarks have a conflict of interest such as banks, as evidenced by the Libor and Euribor scandals in recent years.
With this in mind, the Regulation has four main objectives: (i) to improve controls over the benchmark process and avoid conflicts of interest; (ii) to improve the quality of input data and methodologies and ensure that these are sufficient and accurate; (iii) to ensure that data contributors are subject to adequate controls and conflicts of interests are avoided; (iv) to ensure adequate protection for consumers and investors via transparency, rights of redress and a suitability assessment in some cases.
The Regulation applies to various parties involved in the benchmarking process. The administrator is the party that provides the benchmark. Depending on the nature of the benchmark, it is subject to authorisation or registration. It must also adopt ongoing governance, control and publication measures. Administrators are bound to apply for authorisation or registration within 42 months of its date of entry into force, but may keep practising until authorisation or registration is granted.
Critical benchmarks are subject to the highest level of requirements
The contributor provides the input data upon which the administrator bases the benchmark. Where it is a regulated EU entity such as an investment firm or credit institution, it falls within the full remit of the Regulation and as such will be required to ensure that there is no potential conflict of interest in the data provided, cooperate in the supervision of benchmarks and contribute data for critical benchmarks if required to do so. Where the contributor is not regulated, it has no such obligations but is still required to adhere to codes of conduct developed by administrators in respect of particular benchmarks.
The user of a benchmark is any person who: (i) issues or owns a financial instrument or is a party to a financial contract which references a benchmark; (ii) determines the amount payable under such; (iii) provides a borrowing rate calculated as a mark-up over a benchmark; or (iv) determines the performance of an investment fund through an index.
The Regulation only imposes obligations on users if they are regulated entities, which obligations are that the benchmarks must originate from authorised administrators under the Regulation, and that the user must have robust plans setting out the actions to be taken in the event that a benchmark materially changes or ceases to be produced. Most credit institutions, investment firms, Ucits and AIFMs fall under this category.
The Regulation introduces different obligations according to the nature of the benchmark, determined in terms of the underlying asset, significance and source of data of the benchmark.
Where the underlying asset is an interbank rate (interest rate benchmarks) or commodity (commodity benchmarks), additional requirements apply.
Benchmarks with any other underlying asset are regulated by the less-stringent standard requirements of the Regulation.
The significance of the benchmark will determine the stringency of requirements under the Regulation. Benchmarks are categorised as either critical, significant or non-significant. Critical benchmarks are subject to the highest level of requirements. Significant benchmarks are exempt from some of the requirements of critical benchmarks, but still have higher requirements than the standard.
Non-significant benchmarks are those which are neither critical nor significant. Administrators of such are partially exempt from governance and control requirements and input data requirements, but must still adhere to a number of procedures.
Regarding the source of data, certain data will qualify the benchmark as a “regulated-data benchmark”. Regulated data refers to input data received from, among others, certain EU energy exchanges and EU emission allowance auction platforms. It also includes net asset values provided by licensed investment funds (AIFs and Ucits). Administrators of such benchmarks are partially exempt from certain requirements.
The Regulation also provides for the use of third country (non-EU) benchmarks, subject to certain obligations which must be adhered to by the third country administrators or a ‘sponsoring’ EU administrator.
Central banks and certain public authorities such as national statistics agencies do not fall within the remit of the Regulation.
Nor will the press, other media and journalists fall under such where they merely publish or refer to a benchmark as part of their journalistic activities with no control over the provision of that benchmark.
Luca Amato is an associate at Fenech & Fenech Advocates.