In just over nine months’ time the EU Benchmarks Regulation will come into force in the EU. The Regulation sets common standards across the block to combat the manipulation of financial benchmarks. The main targets of the Regulation are, of course, benchmark administrators. However, the scale of the regulation is such that buy-side firms will likely be caught in its wake.
The full extent of how the Regulation will affect asset managers and other users of benchmarks won’t be known until 2018 at the earliest. However, we are already seeing key consequences of the regulation are coming into focus.
One such is the very real danger that the market for benchmarks might shrink as administrators choose withdrawal over compliance. Even where benchmarks remain, it now seems possible that the quality of the benchmarks will suffer as the number of contributors decline.
This danger was highlighted by Steven Maijoor, Chair of ESMA at a speech he gave at The Hague this January. He noted that the number of banks on the EURIBOR panel have declined to 20 from 40 as a result of ‘actual or perceived compliance risks’. At best, any such decline in contributors to critical benchmark might result in mandated contributions – but it is not clear who would shoulder the cost for these contributions: the bank, or downstream firms in the buy-side.
Cost aside, the integrity and quality of benchmarks is of primary concern to buy-side firms. Fortunately, ESMA is due to issue Technical Standards on this subject on April 1. These standards will have a particular focus on specifying benchmark integrity and reliability requirements in relation to governance, input data and the methodology used, as well as on benchmarks’ transparency.
Another area that has provided concern for buy-side firms based in the EU, is whether they can continue to use benchmarks from third countries. ESMA has confirmed that equivalence rules will apply to third country benchmarks. Under this approach, a country is considered equivalent when its rules are similar and compatible with EU rules.
ESMA has provided a non-exhaustive list of criteria that national regulators should consider when assessing equivalence. These include objective reasons for the provision of a benchmark in a third country, and objective reasons for the endorsement of a benchmark’s use in the EU. Following the recommendations from ESMA’s Securities and Markets Stakeholder Group, it is likely buy-side firms will be provided with a quarterly progress report on third-country benchmark recognition from January 2018.
Over the next nine months the details of the Regulation will be ironed out and further clarity provided, but what is clear now is that from 2018 buy-side firms will likely find the cost and complexity of buying and using benchmarks has increased. Firms that have not already done so, should consider managed data services from providers like RIMES as an alternative to in-house systems. By doing so, they’ll be best placed to mitigate the volatility and cost the Regulation will bring to the market.