In just over six weeks, on 3 January next year, the new Benchmarks Regulation (BMR) will come into effect.
This seeks to rectify certain issues identified as a result of the Libor interest rate manipulation scandals of a few years ago and became EU law in June 2016. It introduces definitions of a benchmark, identifies the role of different organisations and individuals in its manufacture, administration, use and publication, and sets out a number of conditions that must be met by the various parties at each stage of the benchmark creation, dissemination and process of use in order to prevent future manipulation of any kind, including that found in the Libor case.
The regulation will be administered by Esma and applied throughout the EU. Esma’s action instructions will be targeted at national competent authorities (in the UK’s case, the FCA) and as part of this implementation process they have drafted guidelines, yet to be finalised, on the handling of “non-significant” benchmarks. Almost all internal indices currently used by Pimfa member firms will fall into this category.
These draft guidelines address four key areas, each contained in its own chapter: the procedures, characteristics and positioning of the benchmark oversight function; the transparency of methodology; the appropriateness and verifiability of input data; and governance and control requirements for supervised contributors. Each chapter summarises the relevant proposals and objectives and provides an explanation of the related policy issues.
So, what is a “benchmark”? The answer doesn’t hinge so much on what a benchmark references, but rather on how it is used. The Regulation “captures” those benchmarks which are referenced in financial instruments traded on trading venues, or in mortgage and consumer credit contracts, or those used to measure the performance of investment funds. This will cover UK specific benchmarks but will also include, for example, the FTSE 100 (which is not UK specific), the Dax 30, CAC 40, the Baltic Dry indices, catastrophe and weather benchmarks and commodities benchmarks focusing on materials ranging from precious metals to foodstuffs.
A benchmark produced in a “third country” but used in the EU will need to meet regulation standards; the effect of this in the UK following Brexit is of course yet to be determined.
The “non-significant” benchmark guidelines under preparation by Esma are of particular significance to portfolio and asset managers who may combine parts of existing indices together to form a new index or benchmark solely for internal purposes. This activity will be considered “use” of benchmarks already available rather than “administration” of a new one.
Pimfa – the trade body formed from the merger in June of the Wealth Management Association and the Association of Professional Financial Advisors – produces its own indices for retail use in conjunction with the major benchmark manufacturer, MSCI. These are formed from contributions by firms to a survey of the asset classes they have been investing in over particular time periods. Pimfa believes that, since firms contributing to this survey will already be authorised, they are unlikely to require further authorisation as “contributors”.
Firms will need to look very closely at their in-house indices under the new regulation to decide whether they are benchmarks under the broad definitions used; most of them are likely to be.
In this case the benchmarks will have to meet the terms of the new Regulation in the manner in which they are constructed, made public, and used, while the firms themselves may well find that will be considered as administrators of benchmarks as a result of the change in status of their former indices, and that they will have to become authorised for this purpose.
John Barrass is deputy chief executive of Pimfa