The provision of benchmark indices will, for the first time, be brought within regulatory scope in the EU with the impending introduction of the Regulation on Indices used as Benchmarks in Financial Instruments and Financial Contracts, commonly referred to as the ‘Benchmark Regulation’, (the Regulation). The aim of the Regulation is to ensure the accuracy, robustness and integrity of benchmarks and the benchmark setting process. The Regulation introduces a requirement for the prior-authorisation/registration and on-going supervision of benchmark administrators, and prescribes conditions with regard to improving their governance structure; greater transparency of the benchmark production process; and the enhanced supervision of what are termed ‘critical benchmarks’. The Regulation will also apply to regulated entities that contribute to or use benchmarks. As the legislative process progresses, we consider the Regulation and some of its implications for regulated entities that use benchmarks.
The Regulation applies to all published indices that are used to reference the price of a financial instrument or contract, or measure the performance of an investment fund. It introduces an authorisation and supervision framework for all benchmark providers (administrators). A benchmark administrator is the person or entity responsible for the establishment, design, production and dissemination of a benchmark and for the collection of the input data upon which the benchmark is calculated. Applying the principle of proportionality, the Regulation classifies benchmarks as ‘critical’, ‘significant’ and ‘non-significant’, and the nature and degree of the requirements under it will be determined by these classifications. Regulated-data benchmarks are determined by the application of a formula from input data contributed entirely from, (amongst others), trading venues and the net asset values of investment funds. These benchmarks may be significant or nonsignificant only.
Critical Benchmarks: have a total value of at least EUR500 billion, or a total value of at least EUR400 billion in circumstances where there are few if any substitutes and the termination of the benchmark would have a significant impact on the stability and integrity of the financial markets. These benchmarks are subject to enhanced governance and control requirements and are subject to oversight by a college of national supervisors, led by ESMA.
Significant Benchmarks: have a total value of at least EUR50 billion, or a lesser value where there are few if any substitutes and the termination of the benchmark would have a significant impact on the stability and integrity of the financial markets. Administrators of significant benchmarks may dis-apply some of the governance and control requirements under the Regulation having regard to the nature or impact of the benchmark, or the size of the administrator.
Non-significant Benchmarks: are those that do not meet the requirements for critical or significant benchmarks. Administrators of these benchmarks must still be authorised or registered; however there is a ‘comply or explain’ approach to the majority of the governance and control requirements so that only the core principles of the Regulation apply.
The primary impact will be on benchmark administrators, as the Regulation introduces a requirement for their prior-authorisation/registration and on-going supervision. It also prescribes conditions with regard to improving their governance structure and affording greater transparency to the benchmark production process. Notwithstanding the new regime for benchmark administrators, there are also implications for the users of benchmarks. The Regulation will affect all regulated users of benchmarks, in that only benchmarks provided by authorised administrators may be used.
UCITS and AIFM funds
The Regulation includes UCITS and AIFMs as supervised entities. Accordingly they are subject to additional requirements with regard to the use of benchmarks, including:
- They may only use benchmarks that are provided by an authorised benchmark administrator, or a non-EU provider that satisfies the equivalence requirements set out in the Regulation. These requirements include registration and the establishment of cooperation arrangements with ESMA.
- Where the Prospectus of an investment product references a benchmark, information on the administrator’s compliance with the Regulation must be included.
- Robust written plans must be produced outlining the steps to be taken in the event that a benchmark is materially changed or ceases to be produced. These plans and any updates are deliverable to the national competent authority (NCA) upon request.
- Any breaches in respect of the use of a benchmark are subject to a number of administrative sanctions including fines, which may be levied on both a firm and an individual. These range from EUR500,000 to EUR1,000,000, but member states may impose higher maximum sanctions.
What about third country benchmarks?
Benchmarks provided by non-EU administrators may be used under equivalence, recognition, or endorsement procedures.
Equivalence: requires the EU Commission to have made an equivalence decision and that cooperation arrangements are in place.
Recognition: allows third country administrators to be recognised until such time as an equivalence decision is made by the Commission. In order to obtain this prior recognition the administrator must comply with the requirements of the Regulation. This can be achieved by demonstrating compliance with the IOSCO Principles for Financial Benchmarks or the IOSCO Principles for Oil Price reporting agencies (for as long as these compliance principles remain equivalent to the Regulation’s requirements). Compliance with these principles can be assessed by the NCA (supervised entities). The administrator will need to have a legal representative to perform the oversight function and be accountable to the NCA.
Endorsement: where an EU administrator has a clear and well defined role within the control or accountability framework of the third country administrator, which enables it to effectively monitor the provision of the benchmark and there is an objective reason to provide the benchmark in a third country, then the EU administrator may endorse its use in the EU. The EU administrator will remain responsible for the benchmark and all obligations arising from the Regulation.
Formal political agreement on a compromise text was reached on 9 December 2015 and the European Commission has requested the European Securities and Markets Authority (ESMA) to provide technical advice with regard to proposed delegated acts. The European Parliament is expected to vote upon the agreed text in April 2016 with the Regulation entering into force in either late May or early June 2016. The Regulation will apply 18 months after its entry into force.
Sergey is an associate in William Fry’s Asset Management and Investment Funds Department. He advises on the establishment of and operation of all types of Irish investment funds with a particular focus on exchange traded funds. Sergey holds a degree in law (LL.B.) from Trinity College Dublin.
Audrey Giles is a Professional Support Lawyer in William Fry’s Asset Management and Investment Funds Department. She is an Irish qualified barrister, and prior to joining William Fry worked for a number of years as in-house counsel in the banking and financial services sector.
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