ISDA, FIA, GFMA and EMTA have jointly published a briefing advocating an extension of the Benchmark Regulation transition period for critical and non-critical benchmarks.
Industry bodies are asking EU policymakers to extend the transition period of the Benchmarks Regulation for critical and non-critical benchmarks, citing significant negative implications for financial stability in European and global financial markets in addition to competitive disadvantages for European companies.
The briefing was jointly published by ISDA (International Swaps and Derivatives Association), FIA, GFMA (Global Financial Markets Association) and EMTA (Emerging Markets Traders Association), expressing “strong support” for the recent request by the Working Group on Euro Risk-free Rates to EU co-legislators to extend the Benchmarks Regulation transition period for critical benchmarks by a minimum of two years.
Currently, indications are that EURIBOR will be considered compliant with the Benchmarks Regulation, however EONIA may not, unless its definition and calculation methodology are changed. According to the briefing, prohibitions on the use of critical benchmarks have significant implications systemic risk.
An extension in the transition period would also allow time for trades currently referencing EONIA (and potentially EURIBOR) to expire and for their exposures to be replaced with references to ESTER, Europe’s nominated alternative risk-free rate. ESTER is not anticipated to be published on a live basis (post-testing) until at latest October 2019. Until then, there are limits to the steps that market participants can take to prepare for EONIA (or potentially EURIBOR) becoming prohibited.
“Unless sufficient time is allowed for appropriate safeguards to be put in place, the very severe effects brought about by such prohibition (including potential insolvencies, litigation and payment failures) would be felt by EU and global institutions, including pension and investment funds; insurance companies and banking institutions,” the briefing said.
The industry bodies are also requesting “in equally strong terms” that the extension be expanded to include non-critical benchmarks, citing potential “economic damage” to the EU and disruption to its citizens, corporations and other institutions.
EU retail and institutional investors use third country (non-critical) benchmarks provided by administrators domiciled outside the EU for a range of purposes including for hedging currency or market movements, currency conversion, repatriating funds and making cross-border investments.
While it seems likely that a significant number of third country benchmarks may not qualify for use in the EU by the end of 2019, no data is currently publicly available showing the amount of exposure to these benchmarks EU institutions hold. As such, market participants are unable to make any preparations to reduce exposures, putting them at “significant risk of unmitigated losses”.
Further, the briefing noted that EU investors will be put at a significant competitive disadvantage compared to third country investors who will continue to be able to use benchmarks prohibited in the EU after the end of the transition period. There are also unlikely to be alternative rates that EU investors can use in place of prohibited non-critical benchmarks.
Under the existing transition period, third country benchmark administrators may not be able to qualify in time, as equivalence relies upon local regulations which may not be in place or which may only cover specific benchmarks. For example, in Japan, only TIBOR is covered by relevant regulation, which means that significant Japanese equities indices such as the Nikkei 225 or TOPIX would be unable to benefit from any equivalence decision.
The industry bodies warn that prohibiting a large non-critical benchmark or many smaller benchmarks poses a significant risk of market disruption, as each non-critical benchmark may be referenced in up to EUR 500 billion (USD 570 billion) of EU financial contracts.
“Given the absence of information on the benchmarks in question and the lack of available alternatives, market participants are unable to take informed steps to mitigate their risks,” the briefing said. Extending the transition period for non-critical benchmarks will allow third countries time to work with the European Commission to ensure equivalence determinations are in place before any prohibition takes effect, it added.
“Critical and non-critical benchmarks are a vital resource for European citizens and institutions – depriving them of the ability to access them exposes them to risks that they cannot mitigate and places them at a very material commercial disadvantage.”