EU Benchmark Regulation – Not Just a European Problem

APAC benchmark administrators hoping to retain or grow their user base in the EU must take action now to gain approval before 2020, say PwC’s Gregory Campbell and Daniela Bunea.

The BMR Problem

There are tens of millions of benchmarks that are, or could be, used in the EU. Many of these rates are administered by stock exchanges, banks, asset managers and data providers based outside the EU (“third-country administrators”) and, at the time of writing, none are approved to be used from 2020 in the EU.

Why is this a problem? Right now it’s not. But from next year the direct and indirect impact will be extensive both in the EU and beyond:

  • loss of EU customers and earnings for the third-country administrators;
  • market volatility as users seek to close out wholesale positions early where ex-EU reference rates are being used;
  • reduced choice of rates constraining innovation and growth in the EU; and
  • sanctions for EU users up to and including public warnings, removal of permissions, fines and criminal proceedings.

Warning shots were fired in late 2018 by various associations including ISDA, GFMA, FIA, EMTA and ASIFMA about the potential dangers posed by a general lack of readiness for the BMR. The ‘problem’ has remained largely ignored in favour of more diverting and broader impacting current affairs. What is clear, is that the concern is growing and starting to penetrate public consciousness.

Why does it matter for APAC?

BMR has introduced a new common framework to ensure the accuracy and integrity of indices used as benchmarks in financial instruments and financial contracts, or to measure the performance of investment funds in the EU. Most of the provisions in BMR are applicable to firms that administer, contribute to or use benchmarks since 1 January 2018.

Although it is applicable only in the EU, it indirectly impacts third-country administrators where they provide indices that are being used by EU supervised firms. From 1 January 2020, EU supervised firms will only be allowed to use indices provided by administrators formally approved by an EU national competent authority (“NCA”). Although not all benchmarks used in the EU fall under the scope of BMR, ASIFMA estimated in late 2017 that BMR would affect 55 Asia-based benchmarks, including several in Hong Kong, Japan and South Korea. We expect that number to have grown.

In August 2018, the EU Asia Financial Services Round Table stated that ‘…many of the major benchmarks, particularly foreign exchange and interest rate benchmarks, are widely used in Europe’.

An APAC administrator hoping to retain its EU users, or grow this user base in the future (whether for revenue or not) must take specific steps now to start the process to gain approval before 2020.

They can seek approval in the EU via one of three routes: equivalence, recognition or endorsement. More about the steps for applying for approval under each of these routes can be found in these FAQs.

APAC administrators face a series of challenges

Equivalence is simply not an option in the short term. The European Commission has not considered equivalence with BMR yet due to the lack of comparable benchmark regimes in other parts of the world. In APAC, Japan and Singapore currently only regulate certain critical benchmarks. Australia started gradually implementing a series of measures towards establishing a comprehensive regulatory regime for financial benchmarks in 2018. New Zealand and China are also considering introducing their own benchmark regimes, and South Korea is expected to implement theirs this year. However there is unlikely to be any regime approved as equivalent anywhere in the world in the short term, and certainly not in 2019.

This leaves recognition or endorsement, neither of which are straightforward or quick. Deciding which route to take is likely to differ for each administrator based on its specific circumstances. But regardless, APAC administrators have to weigh the commercial benefits of continuing to supply to the EU versus the administrative burden of doing so. In addition, providers of ‘public’ benchmarks without formal licensed users, such as many stock exchange indices, IBORs or national FX benchmarks, must consider the ethical choice in effectively removing their rates from the EU marketplace by taking no action.

Recognition requires an administrator to identify its ‘EU Member State of reference’ and ‘NCA of reference’. The identification is not easy if the administrator is not part of a multinational group and does not know who its users in the EU are or where they are located. This tends to be the case where the administrator does not charge fees for the use of its (not-for-profit) benchmarks. In this case, the administrator may find it difficult to engage a ‘legal representative’ in that Member State to become accountable to its NCA.

The final step is for the administrator to gather and submit a prescriptive set of documents to the NCA.

Endorsement comes with its own challenges. The most significant is to find an endorser that is willing to become legally responsible for the provision of the benchmark(s) and the administrator’s compliance with the BMR. With such responsibility may come interference in the provision of the benchmark, which the administrator may not find acceptable. However there is no prescriptive set of documents required for the application and consequently an expected reduction in later ‘supervision’.

In both cases compliance with BMR must be demonstrated. An acceptable proxy to compliance with BMR is compliance with the IOSCO Principles for Financial Benchmarks or the Principles for Oil Price Reporting Agencies. Here, again, we see confusion as to the steps required to prove this. Under recognition, BMR states that the administrator can obtain an external audit or the home authority can provide a certification of compliance. However, BMR does not give details on the content or form of this home authority certification. In the case of endorsement, the endorser has to prove to its NCA that fulfils requirements which are at least as stringent as the BMR requirements. Generally this is, again, expected to be proof of compliance with the IOSCO Principles.

Also useful to know

The NCA has 90 days to assess the application. In reality this clock will not start until extensive Q&A with the administrator is complete. Working backwards, it is easy to see why so many administrators are prioritising compliance with IOSCO and identification of potential third party partners in Q1 2019.

Brexit also complicates things. Given the UK is likely to be the largest European consumer of benchmarks it means that post-Brexit, third-country administrators will need to apply to both the FCA and an EU NCA if they wish to keep their UK and EU customers. Although it is expected that the UK BMR will eventually be deemed equivalent to EU BMR, such an outcome would still increase the administrative burden for administrators.

As it stands only the largest, and most prudent, of third-country administrators have completed a gap analysis against the IOSCO Principles, with even fewer having commenced the application process. Those that remain appear to be adopting a ‘wait and see’ approach. While understandable, this is a risky road that ends with the vast majority of third-country benchmarks being lost to the EU on 1 January 2020.

One thing is for certain – this time next year a lot more people will be talking about benchmark regulation.

Gregory Campbell is a Director based in the UK, providing advisory and assurance services on financial benchmarks and indices, and leading PwC’s global response to third-country administrators under BMR. Daniela Bunea is a PhD Economist and Senior Associate in the PwC UK Regulatory Centre of Excellence with expertise covering financial benchmarks, LIBOR transition and central clearing.

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