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EU on benchmarks – L’Enfer, c’est les autres

On 27 October 2014, the Fair and Effective Markets Review (FEMR) in the UK published a consultation paper on fixed income, currency and commodities (FICC) markets, with a section dedicated to benchmarks. The Review is led by staff from the HM Treasury, the Bank of England and the FCA. On the same day, the Council of the European Union released the latest EU proposal for regulation on benchmarks.

The UK Review throws sand in the EU regulatory gears, by making the point that while imposing stricter supervision on benchmarks is part of the solution, it is far from being comprehensive. Larger concerns have emerged in the international reports, such as issues with the widespread use of a handful of benchmarks, leading to concentration and dependency. Also, the FSB strongly encourages the transition from benchmarks incorporating a bank credit risk component to risk-free reference rates. As both the current UK regulatory regime and the EU proposal are not designed to address these issues, industry-level measures are likely to play an important role in advancing these initiatives.

Imposing a doctrinal approach to implementing the IOSCO Principles to benchmark providers located in third countries, as envisioned by the EU, may be unnecessarily strict and destined to failure as regulators in other jurisdictions have not shown any burning desire to impose an equally extensive regime. Accordingly, the number of benchmarks eligible for a formal recognition would be next to zero.

In this respect, the latest EU proposal seeks to partially address this concern by proposing an endorsement regime, effectively allowing some third party benchmarks through the backdoor. An administrator located in the Union may endorse benchmarks provided in a third country, provided that certain conditions are met.

In particular, this system would come with a major caveat for the EU benchmark administrator: it would be fully and unconditionally responsible for such endorsed benchmarks. As benchmark administrators are tempted to keep a low profile these days, suggesting that EU administrators would be willing to stick their neck out for another administrator is perhaps a bit presumptuous.

In this context, the EU proposal stresses that the cessation of benchmarks is more than fear mongering. Previous proposals already required that all supervised entities produce a plan setting out the actions in the event that a benchmark materially changes or ceases to be produced. In the latest proposal, all supervised entities would now be required to fully reflect these plans in the contractual relationship with clients. There may be trouble ahead…

Responses to the UK Review can be submitted by 30 January 2015, while the final recommendations will be published in June 2015. As the stakeholders are invited to offer their views on the EU equivalence system, these may be signs that the EU regulation will not be adopted by the end of 2014 as planned.

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