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Is Brussels setting the table for a move away from LIBOR?

On 10 September 2014, the Presidency of the Council of the EU published its first compromise proposal for regulation on benchmarks.

This last version reveals a variety of adjustments since the original proposal published in September a year ago. Although some changes result in a lighter bite for certain benchmark administrators, Brussels is sharpening the knives with regards to critical benchmarks such as LIBOR. This approach echoes recent international developments.

Tougher on critical benchmarks

The Review of the implementation of IOSCO principles by administrators of LIBOR, EURIBOR and TIBOR revealed that the principles hardest to implement concerned the accuracy, reliability and transparency of the benchmarks. In response, the compromise proposal requires that the benchmark methodology must take into account factors including the size and normal liquidity of the market, the transparency of trading and the positions of market participants, market concentration, market dynamic, and the adequacy of any sample to represent the market or the economic reality that the benchmark is intended to measure.

The administrators of critical benchmarks will need to submit a bi-annual assessment of the capability of the benchmarks “to measure the underlying market or economic reality”.  In addition, the appointment of an independent external auditor will be mandatory. A critical benchmarks is used as a reference for financial instruments having a value of at least 500 billion euro.

The desire of regulators to encourage a move away from LIBOR to alternative risk free rates is gaining momentum, particularly in the United States. The European Union’s regulation softly echoes these ambitions. The supervised entities using a benchmark will need to prepare a contingency plan addressing the cessation of a benchmark.

This plan will nominate “one or several alternative benchmarks that might be referenced, provided the administrator of such alternative benchmark consents, to substitute the benchmarks no longer produced, indicating the reasons why such alternative benchmark would nevertheless be less suitable than the benchmark referenced originally.”  In order to fully understand the potential implication of this addition, perhaps it is worth keeping in mind the FSB Report on benchmarks, which advocates for a mass-scale transition from “X”IBORs to alternative risk free rates.

Lighter obligations

Administrators of a “family of benchmarks”, where the input data is of the same nature and provides specific measures of the same market or economic reality, will be allowed to produce a single code of conduct.

Administrators of benchmarks based on input data provided by regulated venues, and other similar sources which makes them less vulnerable to manipulation, will only need to be “registered” – as opposed to being “authorised”.

Registration will take 15 days instead of 60 for authorisation. The Commission will adopt delegated acts to specify the content of the application for registration or authorisation. Naturally, it is expected that less details will be requested for registration since a part of the requirements will not apply, including:

  • Reliability of panel of contributors, which must adhere to a code of conduct
  • Control of input data
  • Corroboration of input data coming from the front office
  • Adequate systems and effective controls to ensure integrity of input data
  • Monitoring of infringement of the Market Abuse Regulation
  • Developing a code of conduct
  • Governance and control for a supervised contributor

Conflicts of interest

By contrast, the provisions on conflicts of interest are strengthened for all benchmark administrators. The provision of a benchmark will have to be operationally and functionally separated from any part of the administrator’s business that may create an actual or potential conflict of interest. If these conflicts cannot be managed, the benchmark administrator will either need to cease the activities or relationships that create these conflicts or cease producing the benchmark.

This additional requirement is likely to accelerate the tendencies already witnessed in the market, where administration of benchmarks is left to dedicated entities e.g. Thomson Reuters Benchmark Services Limited which manages 160 benchmarks. At the same time, the administrators managing only a small number of benchmarks prefer to pass the baton to more specialised entities e.g. ISDA transferring administration of ISDAfix to ICE Benchmark Administration.

The regulation is due to be finalised in December this year and start applying 12 months after.

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