The majority of third-country benchmarks pose no systemic risk but could nevertheless be barred from use in the EU due to a costly and burdensome third-country benchmark regime.
ISDA (International Swaps and Derivatives Association), ASIFMA (Asia Securities Industry and Financial Markets Association), FIA (Futures Industry Association) and the GFXD (Global Foreign Exchange Division) of the GFMA (Global Financial Markets Association) have published a set of recommendations to reform the EU’s Benchmarks Regulation (BMR).
The proposals are aimed at maintaining the intended protections of the BMR while reducing the potential for uncertainty and disruption and preventing EU investors from being put at a competitive disadvantage versus non-EU entities.
A key component of the recommendations is to narrow the scope of the BMR, given that an estimated 2.96 million benchmarks are in use globally, the majority of which pose no systemic risk. Under a general prohibition, none of these benchmarks can be used by EU investors unless they comply with the BMR.
While many EU critical benchmarks have now complied with the BMR, a complex, costly and burdensome third-country benchmark regime means there are concerns that many overseas benchmarks are unlikely to qualify, barring them from use in the EU after the end of the transition period on 31 December 2021.
“The considerable extraterritorial reach of the regulation has resulted in a disproportionate compliance burden for administrators of third-country benchmarks,” said ASIFMA Chief Mark Austen. “The indications are that only large global administrators will qualify their benchmarks, while the majority of third-country administrators will not be incentivised to incur the significant cost and administrative burdens.”
“There are concerns that this will not only negatively impact the ability of EU firms to service their clients’ needs, but also cause disruption and fragmentation in third-country financial markets.”
The prohibition of potentially large numbers of benchmarks would result in EU investors being unable to manage risks that arise as a result of their business activities, and could even pose a threat to financial stability, the associations say.
“Although these may seem like issues for third-country administrators, the inability for EU entities to enter into transactions that reference the spot FX rate of third-country restricted currencies means they are unable to hedge their currency exposure arising from investments in domestic capital markets or local infrastructure,” said GFXD Managing Director James Kemp.
Given no other jurisdictions have implemented similarly expansive benchmark regimes, the current regulations also disadvantage EU retail and institutional investors, making it challenging for them to realise the value of existing positions, convert overseas revenue or repatriate funds.
To prevent this, the associations recommend reversing the general prohibition on use to enable benchmarks to be used in the EU unless specifically prohibited. In addition, only those benchmarks deemed to pose a systemic threat to the EU should be subject to the full scope of the regulation – which would be mandated by an appropriate central authority such as the European Commission or ESMA (European Securities and Markets Authority).
Smaller, non-significant EU and third-country benchmarks, regulated data benchmarks and public utility benchmarks (e.g. FX rates used in non-deliverable forwards) should be exempt from mandatory compliance, the associations say.
As part of the proposals, a voluntary scheme would be introduced to allow out-of-scope benchmarks to be labelled as BMR compliant, acting as an incentive for administrators to meet EU standards on governance and transparency.
To reduce the risk posed by a benchmark ceasing to qualify under the BMR, the associations also recommend replacing the current form of prohibition of use in new and legacy transactions with a ‘no new flow’ proposal. This would prohibit acquisition of net new exposure to benchmarks that fail to comply with the BMR, but permit the use of such benchmarks for managing or reducing legacy positions. End users would therefore be able to transfer their exposure to another entity outside the EU or reduce it by entering into an equal and offsetting trade.
The associations also suggest that enhanced visibility be provided on whether third-country benchmarks have qualified (or been disqualified) for use under the regime via a more usable ESMA register.
“We believe the changes we have proposed are proportionate and achievable,” said ISDA Chief Scott O’Malia. “Our recommendations would ensure the most rigorous safeguards apply to benchmarks that pose systemic risk to the EU, without preventing end users from accessing all of the non-systemic benchmarks they need to manage their risks and compete in a global market.”
The full version of the recommendations and accompanying analysis is available here.