The Practical Implications of the Regulation of Indices and Benchmarks

Index data and benchmarks are growing in significance throughout the buy-side. Data volumes are increasing and so is data complexity. The data is characteristically different from other data sets and is costly to manage. An increasing body of financial regulations exacerbates the data management challenge. Good data governance has become more than desirable; it is obligatory, and firms must act promptly to ensure they remain within the law.

The state of the industry is being shaped by recent events in financial markets. The repeated manipulation of Libor and other key indices has highlighted the critical nature of financial benchmarks and the need for regulation, primarily to remove conflicts of interest and establish clear rules for the setting of benchmarks. Recent EU settlement fines bring the financial sector’s penalties for benchmark manipulation to over $6bn, and this is expected to rise as regulators continue investigations. An industry that was formerly unregulated is now under the scrutiny of regulators globally. Whilst such regulation may be merited, it is likely to have unintended consequences.

The new regulatory regime is driving change throughout the industry. All firms must examine processes and procedures surrounding the management of benchmark data. Sound data governance now plays a critical role in maintaining legislative compliance. The most recent EU proposal heralds a new era in financial regulation, it potentially turns institutional investors or their asset managers, who blend or create composite benchmarks into benchmark administrators. As such they must act to ensure they have the right processes and procedures in place to ensure compliance. Although current proposals may be refined before they become law, the general need for rigorous data governance is unlikely to change.

The impact of new and emerging regulations is being felt throughout the buy-side. All firms must establish clear sightlines from where data is sourced externally to where it is used, distributed and stored within the firm. Although regulations are evolving, firms must act soon to improve data governance and to increase benchmark data transparency. But good data governance comes at a cost. Index data and benchmarks are complex and expensive to manage and although widely used, can suffer from a lack of internal ownership. As firms face spiraling data management costs they must find new ways of operating.

Managed data services offer a flexible, cost-effective solution to the index data and benchmarks challenge. A managed service enables a firm to obtain a holistic view of index data and benchmarks, to understand who is accessing what data, where, why and how. In practice, a managed service offers an immediate and cost-effective solution to the strategic data governance challenge.


An activity characterized by fragmented data that is difficult to manage.

The number of index providers globally is large and increasing. The European Commission’s 2012 Consultation on a Possible Framework for the Regulation of the Production and Use of Indices serving as Benchmarks in Financial and other Contracts highlighted that there are over 500 mainstream index vendors worldwide giving access to hundreds of thousands of indices that track global equity and fixed income security performance and analytics as well as numerous alternative instruments metrics (view footnote 1). These market dynamics mean that buy-side firms must access, store, manage and distribute an increasing volume of index and benchmark data, stemming from a diverse and increasing number of sources.

Index data and benchmarks are fundamental to the investment management business but they are difficult and costly to manage. Research suggests that most asset managers expect this expanding volume to continue and data complexity to increase (view footnote 2). Several underlying factors exacerbate this situation, including:

  • The pursuit of returns amid challenging market conditions
  • A universal requirement for detailed analyses
  • More complex index calculation methodologies
  • Increasingly sophisticated investment techniques

Data complexity is also driven by the proliferation of customized and blended or composite benchmarks, which are becoming more widespread and mainstream in their use. Most investment managers and asset owners also expect the use of customs and blends to increase (view footnote 3). This creates an ongoing challenge for firms who must manage an increasing volume of bespoke data that is often lacking in consistency.

Furthermore, firms must ensure ongoing compliance with a complex array of vendor licensing arrangements, which requires careful monitoring and control of how, where and why data is being accessed and used throughout the business. If this were not challenging enough, a host of new and emerging industry regulations make good governance essential, not just for business success, but also to ensure that firms operate within the law. Firms that invest in good data governance will be well placed to meet the twin challenges of increasingly stringent vendor licensing agreements and the expanding body of external regulations emanating from national and international bodies.

Compliance – a moving target

This paper is a guide to the current state of regulation regarding Indices and benchmarks. It is not an exhaustive compilation of all the regulations in force but offers a summary of the existing and proposed benchmark regulations that affect the buy-side. The paper shows what’s changed, what’s likely to change, and most importantly, what practical steps buy-side firms can take to navigate the path to compliance with the regulations. The new regulatory regime is driving change throughout the industry. Many buy-side firms are examining business processes in pursuit of cost savings and increased efficiency. Some are seeking expert help and are using managed services to improve data governance and prepare for future legislative challenges.

1. Legislation in context

Recent regulatory activity surrounding benchmarks and Indices has been driven by events in financial markets. As we will see, several legislative bodies have acted to bring rulemaking within their domain. This has increased business uncertainty and intensified the compliance challenge for all buy-side firms, and many are struggling to keep up with the latest developments.  Regulatory compliance has also increased operational costs for buy-side firms, and while regulatory compliance is essential, it is not a source of competitive advantage (view footnote 4). As all buy-side firms are grappling with similar regulatory challenges, there is scope for some collaboration to resolve a significant operational challenge facing the industry.

However, there is currently unprecedented regulatory scrutiny and public focus on benchmarks. This stems from concerns about the fragility of some benchmarks, in terms of both their reliability and the continuity of their provision. The integrity of benchmarks is critical to the pricing and evaluation of many financial instruments and also financial risk assessment and management. Benchmarks determine the value of scores of financial contracts, and for leveraged products, the impact of manipulation is magnified in profit or loss. So any doubts about the honesty and accuracy of Indices can undermine market confidence and result in real losses for investors.

The repeated manipulation of various interbank interest rate benchmarks called into question the self-regulatory nature of the setting of benchmarks and served as the catalyst that propelled benchmarks into the regulatory spotlight. However, it must be noted that these were a handful of numerous reference rates and other market indicators that were either manipulated or open to abuse. The Libor and Euribor investigations highlighted the pivotal importance of financial benchmarks and few would doubt that there was a need for regulators to act to provide clear and unambiguous guidance regarding the setting of these benchmarks.

The recent EU settlement fines bring the financial sector’s penalties for benchmark manipulation to over $6bn, and this is expected to rise as regulators continue investigations and private lawsuits multiply.  This will undoubtedly have repercussions throughout the industry. But before discussing the regulation of benchmarks it is necessary to delineate different benchmark types and calculation methods.

Verifiable prices or an expert judgment?

Any discussion about benchmarks must avoid treating indices as a homogeneous entity. Behind the vast volume of published indices lie numerous data points, algorithms and calculation methods. Although most of these are based on verifiable transactions or prices, some are based on ‘expert judgments,’ subjective estimates or voluntary panels. In many instances there is no alternative to the expert view, so there are many outliers and industry specific benchmarks (view footnote 5). Consequently, it is important to distinguish between different benchmark types to avoid oversimplification of the challenge faced by regulators and the implications for users. Any regulatory proposal must ensure a proportional approach by calibrating its requirements to the risks and specificities of different types of benchmarks. Notwithstanding these considerations, most benchmarks share similar vulnerabilities.

2. A regulatory spiral

A global drive to regulate benchmarks and create a universal approach

The regulators investigations into benchmark manipulation thus far concluded that the need for regulation arose primarily from conflicts of interest and the use of discretion in submissions, and that these were not subject to adequate controls and governance (view footnote 6).  Additionally, where benchmarks methodologies and calculations are not transparent, users of benchmarks may be unaware of these risks. Furthermore, an absence of regulatory oversight has meant that historically the authorities have been unable to identify problems early or take the appropriate action to rectify them.

The essence of the Libor flaws was articulated by The Governor of the Bank of England at the end of 2008, when he testified to the Treasury Select Committee:

“It is in many ways the rate at which banks do not lend to each other…it is not a rate at  which anyone is actually borrowing.” Sir Mervyn King 

Following this remark, there has been a flood of commentary and opinion on how best to regulate financial benchmarks. Although Libor is the most frequently cited benchmark in the debate, this really reflects the fact that it is the most commonly utilized benchmark for financial contracts globally, so the economic consequences of any manipulation were most extensive (view footnote 7).  Subsequent to the libor scandal global regulators continue to investigate foreign exchange rate, energy, precious metals and the interest rate swap benchmarks. So clearly the deception has been more widespread than first anticipated.

At a time when there is already diminished public trust in financial service providers, politicians and regulators have been keen to take an aggressive stance in holding the index industry to account. Although few would now question the need for some form of regulation, the rulemaking so far has been fragmented by jurisdiction.  Although several financial institutions and professional bodies have made proposals and suggestions for reform, there are currently three main regulatory initiatives:

  • The International Organization of Securities Commissions (IOSCO) which is the worldwide association of national securities regulatory commissions, including the Securities and Exchange Commission in the USA and the Financial Conduct Authority in the UK.
  • The European Securities and Markets Association (ESMA) and the European Banking Authority (EBA) which seek to protect investors and reinforce stable and well-functioning markets throughout the European Union.
  • The European Commission, which is the executive body of the EU and proposes legislation to Parliament and Council.

The origins of index and benchmark regulation – the Wheatley Review of Libor

The UK was first to investigate how Libor was managed and the Wheatley Review reported in September 2012 (view footnote 8).  The review looked at the structure and governance of Libor and made recommendations on how the system should be reformed. The Wheatley Review confirmed that the vulnerability of Libor emanated from incentives stemming from conflicts of interest. And those conflicts of interest were amplified when ‘expert judgments’ were relied on to determine benchmark rates. The review also noted that vulnerability increased when submitters were market participants with the possibility of significant rewards based on the level of benchmarks.

The important recommendations of the Wheatley review were that:

  • Libor should be reformed rather that replaced.
  • Submissions used for fixing Libor should be supported by transactional evidence rather than by estimates.
  • Market participants should continue to play a significant role in the production and oversight of Libor.

A UK regulatory regime, reflecting the recommendations of the Wheatley Review came into force in April 2013, including criminal sanctions for making false or misleading statements to benchmarks, punishable by imprisonment and fines (view footnote 9).

Implications of the Wheatley Review

The review created a ten-point action plan for Libor (view footnote 10).  This transferred administration from the British Bankers’ Association to NYSE Euronext who will scrutinize submissions, control the submission process, keep records and publicize submission statistics. In practice, making submissions became a regulated activity and subject to the Financial Conduct Authority’s ‘approved persons’ regime.

The Wheatley review is significant in determining the need for regulation of benchmarks. But it also identified the need to identify and remove conflicts of interest in the setting of Libor, and it established ‘transparency’ as a watchword for all those involved in data submission. Other international regulatory work streams have progressed in parallel and subsequent to the Wheatley review.

Current regulations – IOSCO

The principal aim of IOSCO is to coordinate the activities of the world’s securities regulators and to set global standards. IOSCO developes, 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. Standardization of global regulations also eliminates the potential for jurisdictional arbitrage, whereby firms avoid the regulatory regime in one location for a more favorable regime in another.

In July 2013, IOSCO published its Principles for Financial Benchmarks, which focus on the role of the benchmark administrator.

In summary, there are five elements to the IOSCO principles (view footnote 11):

  • 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.

The Principles in the Final Report issued in July 2013 were subtly amended from the draft following the consultation process (view footnote 12) to make clear that transparency to stakeholders “does not mean full disclosure of proprietary information. In particular, summary information and key features may be disclosed to Stakeholders to comply with these Principles (view footnote 13).”  As Frédéric Ducoulombier, Director of EDHEC Risk Institute-Asia explains: “While these principles introduce positive advances with respect to quality of benchmark and methodology, their emphasis is on governance to protect integrity and address conflicts of interest, and on accountability to document compliance. Transparency is approached as one dimension of methodology quality and is limited to the provision of minimal disclosures, on a par with current index industry practices (view footnote 14).”  There are concerns that there are inherent contradictions between the Principles and existing regulations that already apply to certain Indices and benchmarks. Indeed, the final Principles are certainly diluted when it comes to transparency compared to ESMA’s rules for Exchange Traded Funds (ETF’s) and Undertakings for the Collective Investment in Transferable Securities (UCITS) as we will discuss later in this paper.

Ducoulombier considers the final version of the rules do not go far enough and are too weak to be effective as the Principles still allow for opacity in both calculation and methodology when discretion is limited or strong governance processes are in place: “ESMA regards governance and transparency as complements and considers that transparency up to a level allowing historical replication not only is key to mitigating the risk of market abuse but also is central to investor decision making. IOSCO by comparison has considered that governance alone would be sufficient to reasonably reduce the risk of benchmark.” In addition, they may have unintended consequences by imposing expensive governance standards that fall disproportionately on the smaller players which is likely to strengthen the concentration of the industry, with adverse consequences for investor welfare.

Implications of the IOSCO Principles for the buy-side

The Principles seek to promote the reliability of benchmark determination and address benchmark governance, quality and accountability mechanisms. IOSCO’s primary concern was the risk of further benchmark manipulation. The Principles focus solely on the role of the benchmark administrator who must publicly disclose their level of compliance with the Principles by July 2014 and every year thereafter. If implementation in any way deviates from the Principles, the Administrator should explain why it believes it meets the objectives and functions of the Principles, including to the extent they are relying on a proportionate view of the Principles (view footnote 15) .  IOSCO expects the Principles to be implemented globally by the index industry and the role of national regulators to encourage adherence to the Principles through regulation.

All asset managers should ensure they meet with their index administrators in the form of due diligence. They must 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 serve.

One challenge facing buy-side firms is to ascertain whether they are consciously or inadvertently a contributor or submitter of data inputs that are used by an administrator in benchmarks. If so, under Section 14 of the Principles, the firm will be required to enter into a Submitter Code of Conduct (see Appendix below) with the benchmark administrator . This covers, among other things, quality control of submissions, how contributions are generated and who is responsible for them, record retention policies and the guidelines detailing the use of expert judgment (view footnote 16).

“These Principles are intended to promote the reliability of Benchmark determinations, and address Benchmark governance, quality and accountability mechanisms. … to ensure that  Administrators will have appropriate governance arrangements in place in order to protect the  integrity of the Benchmark determination process and to address conflicts of interest.”

IOSCO Final Report

Current regulations – ESMA Guidelines on ETFs and other UCITS issues

The ESMA consolidated guidelines on ETFs and other UCITS (ESMA 2012/832)  became effective in February 2013. The Guidelines sought to increase investor protection, mitigate counterparty risk and increase transparency and disclosure to investors.  The Guidelines have a major impact on managers of UCITS, ETFs and particularly index tracking UCITS. The key issues are considered below:

Index tracking UCITS

The prospectus of index tracking UCITS must clearly describe the Indices, including information on their underlying components. It should direct investors to an appropriate source such as a website where exact components and security weights are published (view footnote 17).

UCITS must disclose the size of any historic tracking error for the period under review in their annual and half-yearly reports. The annual report must disclose and explain the annual tracking difference between the performance of the UCITS and the performance of the index tracked (view footnote 18).

Moreover, and beyond the IOSCO Principles detailed above, the Guidelines also state that UCITS should only invest in financial Indices for which the full calculation methodology is disclosed by the index provider – to enable investors to replicate the financial index (view footnote 19).   This must include detailed information on index constituents, index calculation, rebalancing methodologies, index changes and relevant information on any operational difficulties in providing timely and accurate information.

The Guidelines specify that such information should be easily available to investors at no charge. Moreover, UCITS should not invest in Indices that do not publish their constituents along with their respective weightings, though weightings may be published retrospectively within a calendar month after each rebalancing (view footnote 20).

The implications of the ESMA Guidelines for the buy-side

The Guidelines are more daunting than most investment managers envisaged based on the preceding consultations (view footnote 21). Like the IOSCO Principles, benchmark adequacy is of central importance, but the rules are far more prescriptive than the IOSCO Principles, swapping governance and accountability for clear action points for the index industry around disclosure and transparency of both constituent level data and methodologies.

“An index should not be considered as being an adequate benchmark of a market if it has been created or calculated on the request of one, or a very limited number of, market participants and according to the specifications of those market participants” ESMA Guidelines on ETF’s and Other UCITS Issues Circular 2012/832 §52.

However, there were three Questions and Answers papers released by ESMA (view footnote 22) to clarify the rules which, in the case of the first paper, increased the guidelines scope further. Question 7b asked whether the guidelines were confined to index tracking UCITS. ESMA confirmed that the guidelines applied to any UCITS investing in financial Indices and not only to index tracking UCITS, which significantly widened the impact of the rules.

The European fund management industry is grappling with many challenges arising from the ESMA Guidelines. All affected firms must take action to remain within the rules but exact requirements vary between fund types and according to complexity. However, all UCITS must have complied by the 18thFebruary 2014 at the latest:

  • Disclose the methodology and include in the fund documentation a clear description of the Indices, including information on their underlying components; however, the prospectus can direct investors to a website where the exact composition of the Indices are published, to avoid the need for frequent prospectus updates.
  • Describe how the index will be tracked, for example full replication model, sample replication model or synthetic replication model, and the implications of the chosen method for investors in terms of their exposure to the underlying index and counterparty risk.
  • Include a statement on the anticipated level of tracking error in normal market conditions.
  • Communicate with the index providers to ensure they are correctly licensed to reference the data and websites in their fund documentation.

Legislation proposed by the European Commission

The European Commission has recently published a legislative proposal for the regulation of financial benchmarks.  The proposed regulation addresses concerns about the integrity and accuracy of benchmarks by regulating administrators, contributors and users of benchmarks. All benchmark administrators producing benchmarks based in the EU are within scope, though central banks are exempt.

The proposal is broadly in line with the IOSCO principles and it seeks to create a ‘preventative’ regulatory framework that covers a broad range of benchmarks. In practice, it adopts a blanket approach to benchmarks, and includes all benchmarks that are used to reference financial instruments admitted to trading or traded on a regulated venue, including energy and currency derivatives, those that are used in financial contracts, such as mortgages, and critically the scope extends to those used to measure the performance of investment funds.

The proposed legislation aims to address all possible shortcomings at every stage in the production and use of benchmarks. It seeks to remove any conflicts of interest in the production of benchmarks, while ensuring that they reflect the economic reality they are intended to measure and that they are used appropriately. It expands the market abuse regime to a new offense of making misleading statements and impressions relating to benchmarks. Manipulating benchmarks is clearly and unequivocally illegal and subject to administrative or criminal sanctions.

The proposal covers all benchmark administrators based in the EU who will be required to retain documents and records in relation to submissions, and make these available to competent authorities on request. However, the proposal accepts that criminal sanctions alone will not improve the way in which benchmarks are produced and used and are not a substitute for proper governance of the benchmark process, particularly where conflicts of interest and discretion exist. In order to protect investors, it is essential that benchmarks are robust, reliable and fit for purpose. To that end, the proposed framework has four objectives that cover the way benchmarks are provided, contributed and used:

  • To improve the governance and controls over the benchmark process and in particular to ensure that administrators avoid conflicts of interest or at least manage them adequately.
  • To improve the quality of the input data and methodologies used by benchmark administrators and in particular ensure that sufficient and accurate data is used in the determination of benchmarks.
  • To ensure that contributors to benchmarks are subject to adequate controls, in particular to avoid conflicts of interest and that their contributions to benchmarks are subject to adequate controls.
  • To ensure adequate protection for consumers and investors using benchmarks by enhancing transparency, ensuring sufficient rights of redress and ensuring suitability is assesses where necessary.

The EU proposal recognizes the international nature of the benchmark industry in both production and use. So although action may be taken at national level for national-level indices, the Commission is determined to create a level playing field within the single market. Most EU member states currently have no regulation at national level on the production of benchmarks, so there is an opportunity to produce a harmonized European framework for benchmarks that reflects the fact that benchmarks are used to price and evaluate a wide variety of cross-border transactions, in particular in the interbank funding market and derivatives.

In essence, the EU initiative seeks to enhance the overall efficiency of the single market by creating a common framework for reliable and correctly used benchmarks across member states. While this is a worthy objective, new regulation superimposes a layer of legislative complexity on top of an increasingly complex business environment. So what are the likely implications?

The implications of EU Benchmark Regulation for the buy-side

A very significant impact of the proposal is that all EU supervised entities will have to use benchmarks provided by authorized EU administrators or non-EU administrators that are registered with ESMA (view footnote 23). A ‘benchmark user’ is defined as a person who issues or owns a financial instrument, or is party to a financial contract that references a benchmark.

The practical implications of the proposal are significant. In most cases, supervised entities could have a smaller universe of benchmarks to choose from. Benchmark users must evaluate benchmarks critically to ensure and document that the ones they use are appropriate for the investment vehicle involved. Some investment managers may have to reallocate portfolios or amend existing mandates.

However, there are also complications surrounding the interpretation of the regulation. All supervised investment managers must gain a clear understanding of whether they are benchmark administrators, contributors or users, or a combination of all three. This may be a bigger challenge than it appears. For example, firms that are customizing or blending Indices within a performance measurement team or for retail products would be construed as administering a benchmark under the first draft proposal. And firms may be submitting information, which is used as an input for a benchmark, either knowingly or unintentionally.

3. What firms must do

All firms must act soon to increase benchmark data transparency and to improve data governance.

The proposed regulation is still at the draft stages but momentum has been established, and although it will now be delayed until after the forthcoming European Parliament elections in May, it is widely expected to be passed by Parliament this year (view footnote 24). Although there will be transitional provisions which will permit the use of a benchmark which does not meet the requirements of the regulations, all firms must examine data governance and control processes and procedures. While the burden will be greater for authorized administrators, submitters will also be subject to legislative scrutiny and a code of conduct. Firms need to develop a plan of action to meet the immediate and strategic implications of the regulation. Compliance with the regulation is potentially onerous and will inevitably increase the cost of doing business for many firms. In practice, the new regulation creates some barriers to entry for new benchmark providers and it may also stifle product innovation.

A plan of action for the buy-side

The EU proposal will usher in a new era in financial regulation and provides a platform for the enforcement of the global IOSCO Principles within Europe. The current draft proposal turns institutional investors or their asset managers, who blend or create composite benchmarks (even for performance measurement purposes) into benchmark administrators. The proposal requires all benchmark administrators located in the EU to be authorized by their home state ‘competent authority’. All supervised asset management firms must act to ensure they have the right processes and procedures in place to ensure compliance. All firms must:

  • Catalog all business processes that support Indices and benchmarks throughout the organization, and remove conflicts of interest.
  • Use data that is accurate, transparent and verifiable.
  • Assess and document the risks of any price-setting and dissemination processes which may fall within the scope of the proposed regulation as either a benchmark contributor or submitter.
  • Conduct an internal assessment of whether the firm is to be considered an administrator, a submitter or a contributor under the Proposal. If so, it is necessary to assess the current oversight arrangements for these activities, identifying any shortfalls versus the regulations, and necessary actions to ensure compliance.
  • Contemplate the risks of involvement submission and administration processes in the light of the potential sanctions.
  • Consider using an independent third-party provider for blended and composite benchmarks to remove conflicts, or perceived conflicts of interest.

Conclusion: The need for a new approach

The impact of new and emerging regulations governing indices and benchmarks will be felt throughout the buy-side as their provision and contribution becomes a regulated activity. Principles and standards will apply for all indices and benchmarks including; governance, transparency, quality and accountability. Although the new regulations aim to be proportionate to the problems they address, compliance costs will rise as a result, and are, in many cases, ultimately borne by investors.

At a time when data volumes and complexity are increasing, there is a need for tighter monitoring and control of data to meet regulatory demands for verifiable data processes. Data transparency is of the utmost importance and firms must establish a clear line of sight from when data is acquired until it is used, distributed and stored. Governance and internal controls are in focus, and whilst the burden will be greater for index administrators, particularly as they will have to be explicitly authorized as such, contributors of index submissions are also subject to various requirements including codes of conduct.

Although all firms must be able to demonstrate good data governance, this will come at a cost. Index data and benchmarks are particularly difficult to manage and can suffer from a lack of ownership within the firm. As firms face spiraling data management and compliance costs, marginal business may become unprofitable. Many firms will have to find new ways of working to reduce data management costs, whilst improving data governance and mitigating operational risk.

Managed data services offer a strategic solution to the index and benchmark challenge. A managed service enables a firm to obtain a holistic view of index data and benchmarks, to understand who is accessing what data, where, why and how. In practice, a managed service offers an instant solution to the strategic challenge of data governance. Firms that have a commanding view of their index data and benchmarks will find it easier to fulfill existing regulatory requirements and will be well placed to meet those that are emerging.

Appendix A: Submitter Code of Conduct

(view footnote 25)

Where a Benchmark is based on Submissions, the following additional Principle also applies:

 The Administrator should develop guidelines for Submitters (“Submitter Code of Conduct”), which should be available to any relevant Regulatory Authorities, if any and Published or Made Available to Stakeholders.  The Administrator should only use inputs or Submissions from entities which adhere to the Submitter Code of Conduct and the Administrator should appropriately monitor and record adherence from Submitters. The Administrator should require Submitters to confirm adherence to the Submitter Code of Conduct annually and whenever a change to the Submitter Code of Conduct has occurred. The Administrator’s oversight function should be responsible for the continuing review and oversight of the Submitter Code of Conduct. 

The Submitter Code of Conduct should address:

  • The selection of inputs
  • Who may submit data and information to the Administrator?
  • Quality control procedures to verify the identity of a Submitter and any employee(s) of a Submitter who report(s) data or information and the authorization of such person(s) to report market data on behalf of a Submitter
  • Criteria applied to employees of a Submitter who are permitted to submit data or information to an Administrator on behalf of a Submitter
  • Policies to discourage the interim withdrawal of Submitters from surveys or Panels
  • Policies to encourage Submitters to submit all relevant data
  • The Submitters’ internal systems and controls, which should include:
    • i. Procedures for submitting inputs, including Methodologies to determine the type of eligible inputs, in line with the Administrator’s Methodologies;
    • ii. Procedures to detect and evaluate suspicious inputs or transactions, including inter-group transactions, and to ensure the Bona Fide nature of such inputs, where appropriate;
    • iii. Policies guiding and detailing the use of Expert Judgment, including documentation requirements;
    • iv. Record keeping policies;
    • v. Pre-Submission validation of inputs, and procedures for multiple reviews by senior staff to check inputs;
    • vi. Training, including training with respect to any relevant regulation (covering Benchmark regulation or any market abuse regime);
    • vii. Suspicious Submission reporting;
    • viii. Roles and responsibilities of key personnel and accountability lines;
    • ix. Internal sign off procedures by management for submitting inputs;
    • x. Whistle blowing policies (in line with Principle 4); and
    • xi. Conflicts of interest procedures and policies, including prohibitions on the Submission of data from Front Office Functions unless the Administrator is satisfied that there are adequate internal oversight and verification procedures for Front Office Function Submissions of data to an Administrator (including safeguards and supervision to address possible conflicts of interests as per paragraphs (v) and (ix) above), the physical separation of employees and reporting lines where appropriate, the consideration of how to identify, disclose, manage, mitigate and avoid existing or potential incentives to manipulate or otherwise influence data inputs (whether or not in order to influence the Benchmark levels), including, without limitation, through appropriate remuneration policies and by effectively addressing conflicts of interest which may exist between the Submitter’s Submission activities (including all staff who perform or otherwise participate in Benchmark Submission responsibilities), and any other business of the Submitter or of any of its affiliates or any of their respective clients or customers.


  1.  Collectively, the members of the Index Industry Association (which include MSCI, FTSE, S+P, Russell, Markit and Nasdaq) calculate over one million indices. That is only some of the index providers calculating equity and fixed income Indices and does not include other asset classes such as commodities and real estate.
  2. Collectively, the members of the Index Industry Association (which include MSCI, FTSE, S+P, Russell, Markit and Nasdaq) calculate over one million indices. That is only some of the index providers calculating equity and fixed income Indices and does not include other asset classes such as commodities and real estate.
  3. “90% of participants are expecting an increased need for customized or blended benchmarks as the clients’ needs are getting more and more specific.” –Deloitte Study: Benchmark/Index data management and related costs. January 2013.
  4.  The EU financial services industry is on track to spend €33.3bn from 2012 – 2015 simply to comply with regulatory demands being implemented now according to the regulatory think-tank JWG. This is predicted to approach €50bn taking into account forthcoming initiatives, such as CRD IV, RRPs and Solvency II, spread across 8,500 institutions in the 27 EU nations. Read their research paper ‘Dirty windows: regulating a clearer view’:
  5. Such as the Baltic Exchange Indices giving reference prices for shipping routes, sale and purchase, and recycling of ships. The Baltic Exchange is a neutral party at the heart of the shipping industry, with the sole aim of providing an independent benchmark. It has no financial or other interest in the benchmark figures being higher or lower or biased in favour of one or other interest group.
  6. The Wheatley Review of LIBOR: final report (Sept. 2012) -Failures of the current LIBOR regime – page 79.
  7. Use of LIBOR in Financial Contracts estimates vary considerably according to source. TheWheatley Review of LIBOR – Final Report, estimated that it was approximately $300 trillion (Page 76)
  8. The Wheatley Review of LIBOR: final report
  9. Financial Services Act 2012 and Financial Services Act 2012 – continued
  10. The Wheatley Review of LIBOR: final report
  11. Principles for Financial Benchmarks Final Report
  12. Principles for Financial Benchmarks Consultation Report
  13. Chapter 3 – Discussion of Consultation Feedback. Page 30.
  14. Frédéric Ducoulombier, Director, EDHEC Risk Institute-Asia: “EDHEC-Risk Institute considers that the recurrence of scandals affecting highly-regulated institutions subjected to strict governance rules should lead lawmakers to question the ability of “strong” governance mechanisms to protect investors against abuse. Such scandals have not only underlined the limits of internal controls but also exposed the weakness of the external mechanisms that are expected to further mitigate the risks of abuse.” See –
  15. Frédéric Ducoulombier, Director, EDHEC Risk Institute-Asia: “EDHEC-Risk Institute considers that the recurrence of scandals affecting highly-regulated institutions subjected to strict governance rules should lead lawmakers to question the ability of “strong” governance mechanisms to protect investors against abuse. Such scandals have not only underlined the limits of internal controls but also exposed the weakness of the external mechanisms that are expected to further mitigate the risks of abuse.” See –
  16. The Administrator should develop guidelines for Submitters (“Submitter Code of Conduct”), which should be available to any relevant Regulatory Authorities, if any and Published or Made Available to Stakeholders. The Administrator should only use inputs or Submissions from entities which adhere to the Submitter Code of Conduct and the Administrator should appropriately monitor and record adherence from Submitters. -Section 14. Submitter Code of Conduct; page 25.
  17. See Section V.9.a.
  18. See Section V.11
  19. -Section XIII.55.
  20. Questions and Answers – ESMA’s Guidelines on ETFs and other UCITS issues “Answer 7d: Weightings of index components should be published before the next rebalancing of the index. For example, if an index rebalances on a monthly basis, information on the weightings of the index components should be provided as soon as possible after the rebalancing but within one month of the rebalancing.” ESMA Consultation 25 July 2012/474: Report and Consultation paper
  21. ESMA Consultation 25 July 2012/474  
  22. See ESMA 2013/314 and ESMA 2013/927 and ESMA 2014/295
  23. Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on indices used as benchmarks in financial instruments and financial contracts /*COM/2013/0641 final
  24. The Economic and Monetary Affairs Committee were unable to reach consensus on a final draft in February due to differences of opinion on the inclusion of commodities and the role of leaving ESMA to define critical parts of the scope.
  25. Principles for Financial Benchmarks – Final Report, see pages 25-27


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