A Constructive Approach to the EU Benchmarks Regulation

ISDA Chief Executive Officer Scott O'Malia offers informal comments on important OTC derivatives issues in derivatiViews, reflecting ISDA's long-held commitment to making the market safer and more efficient.

The market-wide transition away from LIBOR has been a colossal undertaking that, while not yet fully complete, has been noted for the meticulous planning and collaboration between the public and private sectors. As the market prepares for the last representative LIBOR settings to cease publication next year, we are taking the same constructive approach to the review of the EU Benchmarks Regulation (BMR).

Last week, we joined with the Asia Securities Industry and Financial Markets Association, the European Association of Corporate Treasurers, EMTA, FIA and the Global FX Division of the Global Financial Markets Association to update our recommendations for changes to the BMR that are designed to reduce the potential for disruption to users of benchmarks within the EU.

Under the BMR and its UK equivalent, users of a wide range of interest rate, credit, FX, equity and commodity benchmarks could suddenly lose access to those benchmarks at the end of transition periods that are due to expire at the end of 2023 in the EU and 2025 in the UK. The regulation prohibits supervised entities from using any benchmark that doesn’t meet its requirements, threatening to strip European and UK firms of the ability to use benchmarks to make informed investment decisions, calculate payments and manage risks.

To put this in perspective, there are just under three million benchmarks in use globally, according to estimates by the Index Industry Association, and the vast majority pose no systemic risk. But the BMR’s third-country regime requires that any benchmark provided by a non-EU administrator would need to qualify before the end of the transition period under one of three routes – equivalence, endorsement or recognition. Given the high cost and compliance burden involved, many third-country administrators have been either unable or unwilling to qualify their benchmarks for use in the EU to date.

With just over 16 months to go until the EU transition period is due to expire, we are concerned about a scenario in which a large number of third-country benchmarks suddenly become unavailable to end users. Depending on the number and nature of the benchmarks affected, this could lead to significant disruption for EU entities, while investors outside the EU would have a competitive edge in being able to continue using those benchmarks.

The updated recommendations, which coincided with the close of the European Commission’s (EC) latest consultation on the review of the BMR, would narrow the scope of the regulation to focus squarely on those benchmarks that would have the biggest systemic impact if they were to fail.

Rather than requiring every benchmark to qualify under the BMR, we believe the assumption should be that all benchmarks can be used unless explicitly prohibited. The EC would need to designate which benchmarks are in-scope, based on pre-defined qualitative criteria, and all other EU and third-country benchmarks would be exempt. Administrators of non-designated EU and third-country benchmarks would still be able to opt into the BMR, but users would not be prohibited from using those benchmarks if their administrators choose not to do so.

While our intention is to avoid disruption and maintain access to the wide range of benchmarks in use today, we do recognize the objective of the BMR to protect investors from poorly administered or failing benchmarks. If a benchmark designated as systemically important fails to qualify or is disqualified, the current rules would leave investors facing the consequences of suddenly being unable to use that benchmark.

The approach taken to ‘tough legacy’ LIBOR contracts recognized that, while firms shouldn’t be able to use the benchmark to acquire new exposure, it was critical that they continue to be able to use it to manage and reduce existing positions by novating to a third party, for example, or by entering into an offsetting trade. We have recommended that these activities, so vital to promoting transition from a failing benchmark, should be safeguarded within the BMR for all systemically important benchmarks.

It has been just over two years since we first published these recommendations, but as the EC moves ahead with its review of the BMR, this was an opportune time to review and update them. As the transition period runs down, we look forward to working constructively with policymakers to ensure that, as for the LIBOR transition, the EU has a robust framework for the supervision of benchmarks of which we can all be proud.

To read the updated BMR recommendations, click here.

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