The European Commission’s (EC) plans to regulate benchmarks go further than what has been agreed at an international level and have met staunch opposition from market participants. Submitters, administrators and users of benchmarks argue that the proposals are disproportionate and too broad in scope. But MEPs are under significant pressure to regulate benchmarks. In the words of one: “This is one of the most highly politicised dossiers. It is now a constituency issue. Voters want to see action on benchmarks, particularly where commodities are concerned.” The EC will push this issue and MEPs recognise the need to reach quick agreement, particularly with the European Parliament election looming.
Financial benchmarks were brought to the public’s attention when the Libor scandal erupted in 2012. Since then, in the UK we have seen manipulating Libor become a criminal offense, a slew of fines and a change in Libor administrator. In Europe, the regulatory response to Libor and Euribor manipulation has included adding criminal sanctions to the Market Abuse Directive for manipulating benchmarks. Meanwhile, at the supranational level, the International Organisation of Securities Commissions (IOSCO) published principles for financial benchmarks in July 2013. The FSB is working on policy recommendations for interest rate benchmarks and will publish a report in 2014.
IOSCO has asked administrators to make a public announcement in July 2014 explaining how well they are complying with the principles. This is an unusual request from a regulator that has typically provided high-level frameworks, and has tended not to seek assurance from market participants that they are complying with its policy recommendations. Given that IOSCO is making this requirement, some question the necessity for the EC’s proposal. However, there is a need. IOSCO principles lack the force of law and may be subject to uneven implementation which could fragment the EU market.Under the EC’s proposal, contributors to benchmarks will have to abide by a legally binding code of conduct, established by benchmark administrators. The EC will specify what the code of conduct for each benchmark should look like. Contributors will also have to make sure that provision of data isn’t affected by any existing or potential conflict of interest. In order to ensure the integrity, accuracy and reliability of data, firms will have to implement control frameworks. The proposals include a requirement that input data should be transaction data. Where this is not possible, verifiable non-transaction data can be used. Verifying non-transaction data will be a challenge for firms, administrators and regulators.
Meanwhile, benchmark administrators will have to be much more transparent about how they produce final benchmark figures from the data that they use. They will have to make public the data used to calculate benchmarks immediately after the benchmark is published – unless doing so would have “serious adverse consequences” for contributors or the benchmark being produced.
The EC’s proposals have caused alarm among industry participants for a number of reasons.
First, the scope is tremendously broad. Industry participants suggest that there are at least one million benchmarks that would be caught by the Regulation. There are a couple of issues here. The level of granularity included in the Level 1 text in the proposed Regulation means that the requirements are sufficiently detailed so as to be inevitably unsuitable for some parts of the market. In addition, requirements around transparency mean that for each benchmark there will be a significant amount of data made available. Therefore, the cumulative amount of data that will be created by the Regulation is enormous. Capturing and storing this amount of data will be costly, and arguably disproportionate to its benefits.
While there are specific sets of requirements for interest rate and commodity benchmarks in the EC’s proposal, these are arguably only a nod towards a truly proportionate regime. Some underline that the IOSCO Principles provide an adequate framework for benchmark governance, and are of a sufficiently high level as to be relevant for a broad range of benchmarks. By contrast, the EC’s proposal looks to be so detailed that application to a wide range of markets and instruments appears problematic.
Another major concern with the EC’s proposal is the inclusion of a third country regime. According to the EC, it is necessary for investor protection that supervision and regulation in any third country are equivalent before any benchmark from that country can be used in the EU. The one, significant, problem with this is an apparent lack of intention anywhere else to develop an explicit regulatory regime which could be deemed equivalent.
It is unclear at this stage whether implementation of the IOSCO Principles would be sufficient for a third country to be deemed equivalent with the proposed Regulation. Although the proposal references the IOSCO Principles, there is a requirement to make sure the “legal framework and supervisory practices” of the third country ensure compliance with the IOSCO Principles. This seems to suggest that a third country regulator simply stating that they are compliant with the IOSCO Principles might not be sufficient. Market participants are understandably worried. European asset managers, for example, rely on benchmarks from all over the globe. Being forced to change the benchmarks that they use would come at a significant cost that asset managers would have to pass on to investors.
The EC is stressing the importance of the European Parliament adopting the text before the elections in May. The lead rapporteur, Sharon Bowles, who is also the chair of the EP’s Economic and Monetary Affairs Committee (ECON), has laid down an ambitious timetable for the EP in order to leave open an opportunity to reach agreement with the Council before the elections, or at least progress the file within the EP to a ‘safe harbour’ from where the new Parliament will be able to continue to progress it as soon as it is established.
Bowles’ draft text, published on 13 November 2013, contains some amendments that will please some of the industry participants who have spoken out against the proposal. For instance, Bowles’ text includes five different categories of benchmark administrators. Such attempts to create a more tailored regime will be welcome.
Some industry participants have expressed surprise that the EC is attempting to progress such an ambitious dossier at such a late stage in the Parliamentary mandate, and have made the suggestion that it would have been better off aiming its sights lower: for example, focusing on dealing with issues relating to Euribor in the first instance, and then addressing benchmarks and indices more widely as a second step in the new Parliament. Some MEPs also believe narrowing the scope could increase the possibility of a timely agreement with the Council but the Council to date has done little work on the proposal.
Given this situation, the temptation may be to conclude that this proposal will not go very far. Even if the EP makes significant progress on the proposal, there is no certainty that the Council or indeed the new Parliament will match their diligence. But now is not the time to put your head in the sand. Both the determination of the Commission and public sentiment may suffice to keep the momentum going on this one. Getting messages across to the current line-up of legislators may not be easy but it could be a question of ‘better the devil you know’. There is no saying how the new Parliament or the new Commissioner will react to this proposal. Clearly, there are some very practical concerns with the current proposals. Engaging with the process in the coming months is key to ensuring that the ECON’s ‘safe harbour’ is a palatable position from which to move forward during 2014.
The European Securities and Markets Authority (ESMA) registered the first trade repositories (TRs) on 7 November 2013, an event which triggers a 12 February 2014 start date for reporting derivative transactions under the European Market and Infrastructure Regulation (EMIR). Both counterparties to a derivative transaction must file a transaction report with an EMIR authorised TR. There are no phase-in periods, exemptions or exclusions for the reporting obligation.
So far ESMA has registered four TRs:
ESMA stated that a TR will be available to receive reports for every derivative asset class, so all derivative classes (interest rate, credit, commodity, currency and equity) will be reportable from 12 February 2014. ESMA expects to register more TRs soon.
As part of the new reporting requirements, EMIR will require all derivative end users to adopt new entity, product and transaction universal identifier regimes. The Legal Entity Identifier (LEI) is a newly created universal entity level identification scheme overseen and administered by the LEI Regulatory Oversight Committee (ROC) based in Switzerland. The ROC has authorised local operating units (LOUs) in several jurisdictions which are issuing pre-LEI codes. A pre-LEI code will be grandfathered when the LEI regime is formally launched next year. For example, in the UK the London Stock Exchange is the authorised LOU, but a derivative end user can apply for a code with an authorised LOU in any country. An asset manager may make a bulk application on behalf of each investment fund and discretionary account (corporate account) that it manages or advises. Firms should seek to obtain pre-LEIs sooner rather than later, and to also monitor and assess ongoing work on product and transaction identifiers.
Light finally penetrated the regulatory fog which had enveloped the European insurance industry when legislators succeeded in thrashing out an agreement on the proposed Omnibus II Directive on 13 November 2013. Omnibus II amends the Solvency II capital adequacy rules for the insurance sector. The deal reached this week in the trilogue negotiations will enable the new prudential regime for insurers to commence in 2016, fifteen years or so after initially conceived.
Insurers should be pretty upbeat with the final text. Politicians have decided to water down requirements in a number of areas compared with the proposals put forward by European Insurance and Occupational Pensions Authority (EIOPA) this summer.
The long-term guarantee package was the main stumping block in negotiations. EIOPA had proposed using a factor of 20% “volatility balancer”. The “volatility balancer” is designed to allow assurers to discount their liabilities in line with short-term fluctuations in asset prices. Insurers don’t need to value assets mark-to-market as their liabilities tend to be illiquid and long-term. This means they don’t need to sell the assets they hold to back the policies before they mature. Officials in Brussels have decided increase the rate substantially to 65%.
Other significant changes on long-term guarantees include:
The new rules potentially are less onerous for Groups with entities operating outside the EEA. Politicians agreed that ‘provisional equivalence’ with Solvency II will be granted to non-EEA countries subject to a number of conditions being met.
Finally the transitional arrangements for implementing certain elements of Solvency II have been extended by up to 16 years—giving insures more breathing space to prepare for the new changes.
In terms of next steps, member states now need to endorse the political agreement reached. Currently, the Parliament intends to consider and vote on Omnibus II at first reading during its plenary session to be held from 3 to 6 February 2014. Before then, the Parliament is expected to vote to adopt the proposed second Directive extending the transposition and application dates of Solvency II (Second Quick Fix Directive). It is scheduled to do so during its plenary session to be held from 18 to 21 November 2013.