New European legislation regulates the provision of, contribution to and use of a wide set of benchmarks.
The ‘regulation on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds’ (EU Benchmarks Regulation) entered into force on 30 June 2016; most of the provisions came into effect on 1 January 2018.
The regulation introduces a common framework and consistent approach to benchmark regulation across the EU. It aims to ensure benchmarks are robust and reliable, and to minimise conflicts of interest in benchmark-setting processes.
Benchmarks and indices defined
The EU Benchmarks Regulation defines an index as a figure that is publicly available and is regularly determined, either by applying a formula or other calculation or making an assessment on the basis of the value of one or more underlying assets/prices (including estimated prices, actual or estimated interest rates, quotes and committed quotes, or other values or surveys).
An index becomes a benchmark within the scope of the EU Benchmarks Regulation where:
- it is used to determine the amount payable under a financial instrument or financial contract, or the value of a financial instrument
- it is used to measure the performance of an investment fund for the purpose of:
- tracking the return
- defining the asset allocation or a portfolio, or
- computing the performance fees
How this affects you
You may be a benchmark administrator if you provide indices that are used in:
- financial instruments traded on trading venues or via systematic internalisers in the EU
- mortgage or consumer credit contracts, or
- investment funds
You may be a supervised contributor under the regulation if you are an authorised person and you:
- contribute input data that is not readily available to the administrator, and
- provide the input data for the purpose of a benchmark determination
You may be a benchmark user and be subject to additional requirements if you are supervised under MiFID II, CRD IV, UCITS or one of the other EU regulations as specified in Article 3(1)(17) and you:
- issue a financial instrument that references an index
- determine the amount payable under a financial instrument or a mortgage or consumer credit contract by referencing an index
- are a party to a mortgage or consumer credit contract that references an index
- provide a borrowing rate calculated as a spread or mark-up over an index or a combination of indices and that is solely used as a reference in a consumer credit contract to which the creditor is a party
- measure the performance of an investment fund through an index either to track the return of the fund or to define its asset allocation
The different types of benchmarks
The EU Benchmarks Regulation groups benchmarks into six different types:
- Critical benchmarks – where the value of contracts underlying the benchmark is at least €500bn, or where a benchmark has been recognised as critical in a Member State.
- Significant benchmarks – where the value of contracts underlying the benchmark is at least €50bn, or where there are no or very few market-led substitutes and there would be an impact on financial stability if the benchmark ceased to be produced.
- Commodity benchmarks – where the underlying asset of the benchmark is a commodity as defined by MIFID II. Commodity benchmarks are subject to the requirements set out in Annex II of the regulation unless they are regulated data benchmarks, or are based on submissions the majority of which are supervised entities. The articles relating to significant and non-significant benchmarks do not apply to commodity benchmarks.
- Regulated data benchmarks – where the input data to the benchmark is provided directly from regulated venues. Certain provisions of the regulation do not apply to regulated data benchmarks, and they cannot be classified as critical.
- Interest rate benchmarks – where the benchmark is determined on the basis of the rate at which banks may lend to, or borrow from, other banks or agents in the money markets. Interest rate benchmarks are subject to the requirements set out in Annex I of the regulation. The articles relating to significant and non-significant benchmarks do not apply to interest rate benchmarks.
- Non-significant benchmarks – where the value of contracts underlying the benchmark is less than €50bn, and the benchmark is not a commodity or interest rate benchmark.
Benchmark administrators - authorisation or registration
There are two ways that an EU benchmark administrator can be approved under the regulation: authorisation or registration.
If you need to be approved as a benchmark administrator, the diagram below will help you decide which route to take.
Equivalence, Recognition and Endorsement
In order for supervised entities in the EU to be able to use benchmarks produced by third country administrators (eg US, Japan, Australia), those administrators must apply to be added to the ESMA list of benchmarks in one of three ways:
- Equivalence – where an equivalence decision has been adopted by the European Commission.
- Recognition – where an administrator located in a third country has been recognised by a Member State in accordance with the requirements set out in Article 32 of the regulation.
- Endorsement – where an administrator or supervised entity located in the EU with a clear and well-defined role within the control or accountability framework of a third country administrator and is able to monitor effectively the provision of a benchmark, applies for endorsement in accordance with the requirements set out in Article 33 of the regulation.
It is important that administrators, users and contributors fully understand and comply with their obligations under the regulation. If you are not sure whether you fall within the scope of the regulation, you can contact us at [email protected]