In this article series, we have been looking at the EU Benchmarks Regulation (BMR) through the lens of RIMES’ recent BMR Seminar. In this concluding article, we report on the presentation of Joanna Perkins, Chief Executive of the Financial Markets Law Committee. Perkins used her presentation to outline the evolution of BMR and set out its likely impact on key benchmarks.
Perkins began by reminding attendees to the seminar that benchmark reform is a tale of two divergent paths: evolution and regulation. When it comes to benchmark evolution, new methodologies have been planned for all major benchmarks – although not all changes been implemented. Perkins gave an overview of the major changes, which included:
- EURIBOR – Attempted to base the rate entirely on transactions (i.e. removing the element of expert judgement). This attempt was abandoned as the projected values for the new methodology could not be brought into line with projected values for EURIBOR.
- TIBOR/LIBOR – A review of TIBOR and LIBOR has proposed retaining expert judgement as an input for the benchmarks, as it is deemed a sensible safety net for indices which rely on data from a shrinking unsecured lending market.
- SONIA – The administration of the benchmark has been transferred to the Bank of England which is introducing bilaterally agreed transactions as well as brokered transactions, and has proposed using a volume-weighted, trimmed-mean calculation.
The evolution of benchmarks, and benchmark methodologies is not without its challenges. Perkins referred to the FSB’s 2014 statement that while benchmark evolution is desirable, it is not without its risks; particularly around increased litigation and the possibility of contract frustration. At the same time as the FSB made this statement, an industry report listed four possible pathways for minimizing risk:
- Seamless transition – Where an existing benchmark is transitioned from one methodology to another
- Successor rate pathway – Where a withdrawn benchmark is replaced by one with a similar identity
- Market -led transition – a process of voluntary adoption of a new benchmark, which is offered in parallel with an existing benchmark
- Cutover transition – a process which allows a legacy benchmark to run in parallel with a new benchmark, with a clear deadline in place for the termination of the legacy benchmark
Perkins then addressed at the second driver of benchmark reform: regulation. Perkins reminded the audience just how wide ranging BMR will be, applying as it does to all benchmarks used for valuation purposes or incorporated in to financial instruments, provided they are made available to the public and provide some element of regular calculation.
With BMR, as with the evolution of benchmarks, the issue of expert judgement is pertinent. Perkins believes that BMR is ambiguous about whether BMR allows the use of expert judgement as an input into a benchmark. However, in its technical standards ESMA has accepted wholeheartedly the use of expert judgement as an input, perhaps a reflection of the difficulties administrators face in obtaining significant transaction data inputs.
Another key issue raised by Perkins is what happens in the case of a cessation of a benchmark. Perkins explained that ESMA has established disclosure requirements for administrators for critical and significant benchmarks to indicate the circumstances where they may no longer be viable.
Significantly, this is not the only measure being taken to ensure a smooth transition to the BMR regime. The Regulation includes generous transitional provisions that will ensure the smooth functioning of the market during the adoption period. Importantly, non-compliant benchmarks will not need to be withdrawn straight away, and can still be adopted in to new contracts until authorisation is refused or until 2020.
Perkins concluded by reminding attendees that markets that use benchmarks are subject to a high degree of standardization in contract terms and so the smallest chance of litigation around contract frustration does not need to be successful to be disruptive. However, many contracts contain fullback clauses, and history is full of smooth transitions. The regulation does sets strict standards, and will have a huge effect on the market, but it also preserves continuity with some generous transition arrangements.
From RIMES perspective, while buy-side firms should not panic unduly about the impact of the Regulation on benchmarks, it is still advisable to prepare for disruption. By taking managed data services from providers such as RIMES, firms can protect themselves from even the most volatile benchmarks market, ensuring they can continue to deliver high-quality products and services to their clients.
To watch Joanna Perkins’ presentation in full, click here.
RIMES has put together an easy to use BMR Checklist questionnaire for you to understand how you may be affected by the BMR.