The International Organization of Securities Commission (IOSCO) published a Review of the Implementation of its Principles for Financial Benchmarks last Wednesday. The report sets out the findings of IOSCO´s appraisal of a sample of Administrators of financial benchmarks across a range of geographical areas and asset classes.
The Principles were published in July 2013 with the aim of creating an overarching framework of principles for benchmarks used in financial markets, covering governance and accountability as well as the quality and transparency of benchmark design and methodologies. IOSCO’s primary concern was the risk of further benchmark manipulation and its impact on the financial services industry and the wider economy.
The focus of the Principles was solely on the role of the benchmark Administrator who had to publicly disclose their level of compliance with the Principles by July 2014 and every year thereafter. If the Administrators implementation of the guidelines in any way deviated from the Principles, the Administrator had to explain why it believes it meets the objectives and functions of the Principles, including to the extent they were relying on a proportionate view of the Principles. IOSCO expected the Principles to be implemented globally by the index industry and the role of national regulators to encourage adherence to the Principles through regulation.
The Review was intended to provide high level information about the extent of the voluntary market adoption of the Principles, with a view to understanding what Administrators have done, and what remains to be done to implement the Principles. The key findings of the Review include:
- The benchmark industry is in a state of unprecedented evolution, as seen from the reported levels of Administrators continuing to work towards compliance with the Principles as well as examples of benchmarks being transitioned to new Administrators and methodologies or their cessation;
- There has been widespread and substantial efforts to implement the Principles;
- Additional actions may need to be taken by IOSCO, but it is premature to speculate what those actions might be.
The Chairman of the IOSCO Board-level Task Force and Chief Executive of the UK Financial Conduct Authority Martin Wheatley said in a statement: “Benchmark Administrators have taken significant steps to implement the principles across their business, however there is more to do to ensure standards are raised across the market. The principles play a vital role in this, and I welcome the public confirmations of compliance made by Administrators to date.”
The Review was conducted by taking a sample of 36 Benchmarks (which are provided by 23 Administrators) that are either widely used or sector-specific Benchmarks, across a variety of regions and assets classes. Information was collected directly from the Administrators through a questionnaire and indirectly though examination of any statements of compliance they had published. As such, the Review is based solely on Administrators’ self-assessments of their compliance with the Principles, and was not a detailed audit of the Administrators by IOSCO.
The Review indicated that there has been a significant market reaction to the publication of the Principles, with widespread efforts being made to implement the Principles by the majority of the Administrators surveyed. The responses received also showed that the benchmarks industry is in a state of change, as seen from the reported levels of Administrators continuing to work towards compliance with the Principles as well as examples of benchmarks being transitioned to new methodologies and Administrators. The report notes that further steps may need to be taken by IOSCO in the future; however it is too early to determine what those steps should be. The report charted the steps towards compliance and the detail of the compliance statement by asset class in Fig 1, below.
Fig 1. Chart representing the steps towards compliance and detail of compliance statement for each of the reviewed Benchmarks
Administrators of equity Benchmarks reported the highest level of compliance, with most having published a statement of compliance. In several cases, external auditors had been commissioned to consider whether these statements were fairly stated. Administrators of fixed income and commodity Benchmarks exhibited the highest reported levels of transition to new Administrators and under half stated that they were aligned with the Principles.
There was also a significant amount of work reported around analysing Benchmark design with some Administrators stating that they had moved from a Benchmark based on Submissions to one built on transactions. The Review found that around 20% of the Benchmarks within the sample are currently, or have recently been, in a process of cessation or transition to new Administrators. The wind-down of individual tenors or whole Benchmarks was occurring where the level of input data was not deemed sufficient for the Administrator to be satisfied that the Benchmark would be robust.
Approximately half of the Administrators of the Benchmarks reviewed stated that they had applied proportionality in their implementation of the Principles. This was most frequently applied to Principle 14 which concerns Submitter Codes of Conduct. The level of proportionality was not always clear in statements of compliance published by Administrators and, in fact, for just under half of the Administrators, the Review Team could not find a published statement disclosing the actual level of compliance with the Principles.
In summary, there are five elements to the Principles:
- Governance – Establishing credible and transparent governance, oversight and accountability procedures for the benchmark determination process, including an identifiable oversight function accountable for the development, issuance and operation of the benchmark to protect the integrity of the benchmark and to address conflicts of interests.
- Quality of the benchmark – The benchmark should seek to achieve, and result in an accurate and reliable representation of the economic realities of the interest it seeks to measure, and eliminate factors that might result in a distortion of the price, rate, index or value of the benchmark. These principles address the design of the benchmark, the data used to construct it, including data sufficiency and use of ‘expert judgment’.
- Quality of the methodology – The Administrator should document and publish or make available the methodology used to make benchmark determinations, and provide the rationale for adopting a particular methodology. It must provide sufficient detail to allow stakeholders to understand how the benchmark is derived and to assess its representativeness, relevance and appropriateness. These policies and procedures should be proportionate to the estimated breadth and depth of contracts and financial instruments that reference a benchmark and the economic and financial stability impact that might result from the cessation of the benchmark.
- Accountability – These principles establish complaints processes, documentation standards and audit reviews that are intended to provide evidence of compliance by the benchmark Administrator as defined by these principles and their own policies, as well as making information available to relevant market authorities. Subject to applicable national legal or regulatory requirements, the Administrator must retain records for five years, to safeguard necessary documents for audits, and cooperate with regulatory authorities as required.
- Transparency – An overarching theme throughout the principles, specific examples include: ensuring appropriate transparency over significant decisions affecting the compilation of the benchmark and any related determination process, including contingency measures in the event of absence of or insufficient inputs, market stress or disruption, failure of critical infrastructure, or other relevant factors, for example a concise explanation of the extent to which and the basis upon which expert judgment if any, was used in establishing a benchmark determination.
RIMES recommends that asset managers should ensure they meet with their index Administrators in the form of due diligence. They should ask them to confirm their adherence to the Principles in writing and also detail any areas where they do not comply with the Principles and the justification or rationale behind that decision. Individual asset managers can then decide if they are content with the response or consider it to be a risk to themselves and the end investors they service.
The primary aim of IOSCO is to coordinate the activities of the world’s securities regulators and to set global standards. IOSCO develops, implements and promotes adherence to internationally recognized standards for securities regulation and is working closely with the G20 and the Financial Stability Board (FSB) on the global regulatory reform agenda. IOSCO plays a crucial role in harmonizing financial regulations across multiple jurisdictions, which promotes regulatory harmony and consistency. The organization’s membership regulates more than 95% of the world’s securities markets in more than 115 jurisdictions and it continues to expand.
The IOSCO Review of the Implementation of IOSCO’s Principles for Financial Benchmarks, 25 February 2015, is available here.
The IOSCO Principles for Financial Benchmarks Final Report, July 2013, are available here.