Although the EU Benchmarks Regulation (BMR) came into force on January 1, 2018, benchmark administrators have been given a period of grace to seek authorization or registration for benchmarks already in use. The aim of this period of grace, which ends in January 2020, has been to give administrators, benchmark users and the wider markets sufficient time to adjust to the new regulatory regime. However, as the full implications of BMR fall into focus it is becoming clear that as 2020 draws near, severe uncertainty will remain over which rates and indices firms should use in their financial instruments and contracts.
Two rates in particular are providing cause for concern: Eonia and Libor. Eonia (Euro OverNight Index Average) is used to discount future cashflows for euro swaps that are capitalized with cash. As the rate will not be able to comply with BMR it is earmarked for likely replacement by the euro short-term rate Ester. However, with Ester only due to be ready by October 2019, firms will have only three months to integrate the rate into their overnight indexed swap models. This could create significant valuation problems in the market.
The future of Libor, and its potential replacement, is also unclear. If Libor is replaced, firms will be required to reference alternative risk-free rates, such as Sonia, in their contacts. However, with some banks willing to keep Libor active beyond 2020, it’s uncertain when, or if, firms should fall back on these risk-free rates. Valuation teams within firms therefore have their work cut out over the next couple of years as the benchmarks landscape continues to shift.
The key question for benchmark users today is how they can mitigate the uncertainty caused by BMR. This is a critical question: not only do firms face stiff penalties for non-compliance with BMR, but the wider financial market is at risk if the transition to the new benchmarks regime is volatile.
One approach is to leverage the fast-growing market for RegTech services, such as those offered by RIMES. These managed services allow firms to ‘plug in’ to a wealth of regulatory expertise and knowledge. Moreover, these services can help firms cost-effectively keep on top of the changing benchmarks market: firms can ensure the benchmarks and rates they use are fully compliant with BMR and that they have replacement benchmarks ready-to-go in case of market volatility. The next few years are going to be testing ones for benchmark users, but firms that arm themselves with agile compliance solutions will be well-placed to weather the storm.
To receive more information about RegFocussm BMR, the most advanced benchmarks validation solution on the market which solves all regulatory obligations under the new Benchmarks Regulation, please contact us.
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