The EU Benchmark Regulation (“EU BMR”) became effective on 1 January 2018 and seeks to increase the robustness and reliability of financial benchmarks and protect them from the type of manipulation that occurred during the financial crisis. Whilst the regulation was effective from 1 January 2018, the text includes transitional arrangements for existing EU and third country benchmark administrators, allowing these administrators to apply for authorisation any time before 1 January 2020.
On 26 February 2019, the European Council and Parliament reached a political agreement to amend EU BMR to extend the transitional provisions for critical and third country benchmarks for a further two years to comply and undertake the requirements in the regulation .
This blog explores why an extension to the transitional arrangements was agreed, what has changed, the impact of the extension and what benchmark administrators, contributors and users should be doing now.
Why are we here?
Critical benchmarks are defined under the EU BMR as benchmarks that would have a significant and material impact on market stability and the real economy if they ceased to be published. Currently, the EU Commission has1 designated the following benchmarks as critical: LIBOR , EONIA, EURIBOR, STIBOR and WIBOR.
Of those benchmarks, only the administrator of LIBOR, ICE Benchmark Administration Ltd. has been authorised by the UK FCA2. European Money Markets Institution (“EMMI”), the administrator for EURIBOR and EONIA has publically stated its intention to obtain authorisation by the end of 20193 . However, whilst EMMI as an administrator may be able to obtain authorisation, significant challenges remain with both the EURIBOR and EONIA benchmarks which meant their ongoing use beyond 1 January 2020 remained uncertain.
The current methodology for EURIBOR is not compatible with the requirements of EU BMR and a revised methodology has been designed and planned to be implemented by EMMI by the end of 2019. The challenges for EONIA are more fundamental and EMMI have announced that, due to inherent limitations in its design, it is not possible to make the benchmark BMR compliant, requiring the benchmark to be replaced.
The European Central Bank (“ECB”) Working Group on Euro Risk-Free rates was set-up to identify alternative risk free rates for the Eurozone and selected €STR (Euro Short Term Rate) as the alternative rate for the Eurozone. This rate is due to be published daily from October 2019 and is a potential successor rate for EONIA4 .
The original timeline would have provided only 3 months to transition from EONIA to €STR, which could pose a systemic risk should any delays be encountered. Furthermore, there remains a risk that the reforms required for EURIBOR may be delayed and this benchmark could be unavailable too. Consequently, in September 2018, the ECB Working Group on Euro Risk-Free rates requested an extension of the transitional arrangements for a further two years to 2022, noting that, given the timeline, it would be challenging for institutions to transition to €STR by the end of 2019.
A contributing factor for the extension going to the end of 2021 aligns the transition to the expected cessation dates for LIBOR and EONIA. The UK FCA announced that they will remove powers to compel panel banks to contribute to LIBOR by 31 December 2021 and EMMI are currently consulting on the cessation date for EONIA to be on 3 January 20225.
Third country benchmarks
As discussed in our previous blog, administrators based outside of the EU have three options (equivalence, recognition and endorsement) to comply with the regulation and allow their benchmarks to be used in the EU beyond 2019. Equivalence can only be sought by the NCA of a third country, leaving recognition and endorsement as the two routes available to administrators where equivalence is not available.
There are challenges with both of these options and when the extension was announced, there were no third country benchmarks included in the ESMA Register. Whilst some third country administrators were working to achieve approval by the end of 2019, the expectation was that many would not meet the deadline, therefore limiting the use of their benchmarks in the EU. Industry bodies such as ISDA and AFME6 have raised concerns as to whether third country benchmarks as well as highlighting the challenges of the practicability of these routes.
There has been a lack of practical application guidance on how to apply for recognition and endorsement from ESMA, which has led to confusion with third country administrators on which option is most appropriate and how to interpret the requirements. There has been a lack of awareness from certain industries (such as media) and countries which led to inertia in the market on how to comply.
What are the next steps?
The extension has provided breathing space to those impacted by the regulation; however, the following steps should be prioritised to ensure firms maximise the extension given.
There is a question of whether the published list of critical benchmarks will be updated before the end of 2019 with further critical benchmarks that might be identified. EU administrators that think they administer a critical benchmark should immediately consult with their local EU competent authority.
The ECB Working Group has indicated its preference for EONIA to be modified to €STR plus a spread for a limited period (expected by the end of 2021) which could be implemented by October 20197.
Given the extended transitional period, firms should incorporate EONIA transition, and other IBORs which are potentially transitioning to alternative risk free rates to their wider programmes around IBOR reform.
Third country benchmarks
The practical application of the third country requirements for administrators needs careful, and focused consideration, given the lack of third country administrators on the ESMA register at present. Arguably, the future success of the Regulation could be measured in part, by the level of adherence to it by those administrators from outside of the EU.
For equivalence, there is a need for increased clarity on the European Commission’s timeline for making a decision so that firms can initiate alternative plans if an equivalence decision will not be made in time. It should be noted that the Commission has recently published draft equivalence decisions for Australia8 and Singapore9 for a small number of benchmarks administered in these jurisdictions.
For firms looking to apply for recognition, transparency on how third country firms can find and use appropriate market data (such as the FIRDs database) to identify the member state of reference is required. Additionally, firms have raised concerns over how to establish legal liabilities between the third country administrators and the EU legal representative or endorser and whether to wait to apply directly to ESMA.
Firms have indicated confusion on whether NCAs will recognise the IOSCO Principles10 as being stringent to the requirements of EU BMR to assess compliance to the regulation. It may be expected that for endorsement, an external assurance report of compliance to IOSCO will be needed for the endorser to assess compliance, increasing compliance costs for firms. Indeed, the important role that third party independent assurance can provide also needs clarification.
Third country administrators should be aware of the review of powers for European Supervisory Authorities11 . A political agreement has been achieved between the EU Commission and Parliament12 where third country administrators and their legal representative would be supervised by ESMA and need to apply to ESMA directly for recognition rather than the relevant EU NCA.
In light of these concerns, the European Commission will submit a report to Parliament and the Council on the operation of the third country regime by April 2020, its implementation in practice and its shortcomings. This will include an assessment of whether the third country regime requires amending. Firms are encouraged to engage with industry bodies and the Commission to ensure industry concerns are raised.
With uncertainty around the UK’s exit from the European Union, which is expected to happen during the extended transitional period for EU BMR, the UK Government issued an explanatory information document to the Benchmark Regulation in January 201913 . This provided some clarification on the impact of Brexit for administrators, including the designation of the FCA as the sole regulator for UK BMR.
Third country firms applying for recognition to the UK and EU will need to apply twice and will need to have legal representation in each jurisdiction, further increasing compliance costs. Third country firms included on the ESMA register on Brexit day will have an additional 24-month period to apply to the FCA.
Potential US regulation
Concerns around conflict of interest around equity-linked indexes have led for calls within the US for a review of benchmark administration14 , conflict of interest and potential manipulation of benchmarks as there is no US regulation of financial benchmarks. The CFTC, in October 2018 established a new subcommittee for interest rate benchmark reform within its Market Risk Advisory Committee and their mandate does cover regulating use of benchmarks. Firms should be aware of any developments or reviews that could result in legislation over use of financial benchmarks, including administrators.
The extension to the transitional arrangements for critical and third country benchmarks has moved the timeline but, as yet, has not altered the requirements that administrators, contributors and users have to comply with. Firms should use this time wisely, in raising awareness and making plans to help ensure compliance well in advance of 2022.
The extension also provides the regulation the time and platform to engage with the industry and allow the market to get behind it. This time allows EU regulators time to clarify some of the requirements and aligns timing with wider reforms of interest rate benchmarks.
Third country administrators
With the extension, awareness of the regulation and its implications is key to ensure that firms are aware and assess the viability of the three options available. Firms should consider how to drive advocacy and engage with regulators and industry bodies to ensure any concerns on the practicability of the third country regime are considered; especially with the review of the regulation by the EC in the next year. Firm plans on the BMR should consider the impact that Brexit will have, such as identifying another legal representative.
Firms using benchmarks should, with immediate priority, review their benchmark inventory and identify which benchmarks: are EU-based; have not been approved for use; and engage with administrators to understand whether they will be able to comply in time.
Users are encouraged to ask critical and third country administrators of their plans to comply with the regulation, regardless of the extension.
Firms should engage with administrators of these benchmarks and assess the likeliness that they will comply with the regulation in time and whether alternative benchmarks or contingency plans need to be activated.
The extension allows firms to incorporate compliance to the regulation for critical and third country benchmarks to their IBOR transition programmes and allows firms to appropriately plan for the transition of benchmarks such as EONIA to suitable alternative risk free rates alongside LIBOR.
Firms that contribute to benchmarks currently not on the register should engage with administrators to understand whether the benchmarks will be approved for use in 2019 or the benchmarks qualify for the extension. Contributors are encouraged to pro-actively be involved in the development of any Code of Conduct to ensure there is no ‘hidden-surprises’.
1Regulation (EU) 2019/482 https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=uriserv:OJ.L_.2019.082.01.0026.01.ENG&toc=OJ:L:2019:082:FULL
2ESMA Register for Benchmark Administrators on 28 March 2019 (https://registers.esma.europa.eu/publication/searchRegister?core=esma_registers_bench_entities)
10https://www.iosco.org/library/pubdocs/pdf/IOSCOPD415.pdf and https://www.iosco.org/library/pubdocs/pdf/IOSCOPD391.pdf