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When even benchmark waterfalls become a free fall

On 23 October 2015, the Financial Markets Law Committee (FMLC) published a letter highlighting certain issues with regard to the proposal[1] for EU regulation on benchmarks.

It was well-known that the regulation would impose a heavy burden on benchmarks established outside the EU, as the United States has been very vocal about the initiative. With the letter from the FMLC, the spotlight shifts to emerging markets.

The letter focused on potential issues with non-deliverable forward (“NDF”) contracts referencing emerging markets currencies (“EMCs”). For certain EMCs, there would be little or no choice as to the benchmarks available and the FMLC doubts that their deemed administrators would be able to meet the requirements imposed by the EU regulation.

As the regulation provides that supervised entities may only use a benchmark as a reference in financial instrument or financial contract if the administrator has been approved by the EU, this would result in the benchmarks being banned – and by extension the NDF contracts would be affected.

The FMLC is concerned that this situation might affect contractual continuity and cause a run on the outstanding FX contracts. Even the embedded waterfalls in certain standard contracts would not alleviate the concerns. Such waterfalls are designed to provide certainty when difficult market conditions render certain benchmarks unavailable.

It is certainly not too late for the EU to retreat, as the trilogue negotiations continue. Asking benchmark administrators to be armed at all points exactly cap-a-pe could otherwise bring an end to EMC benchmarks and other benchmarks unable to face the regulatory pressure.

The FMLC would propose a carve-out of the EMC rates from the EU regulation.

[1] In reference to the proposal dated 20 May 2015, as a final text has not been agreed yet.

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