The EU’s benchmarks regulation is accused of risking the further fragmentation of global markets as it will potentially make it harder for EU-based firms to use non-EU benchmarks for everything from investing to hedging. Justin Pugsley reports.
What is happening?
The EU’s benchmarks regulation (BMR), which goes fully live on January 1, 2020, comes with an onerous set of obligations that are designed to make benchmarks more robust and trustworthy.
Benchmarks are extremely important to the global financial system, acting as references to just about every asset class, including derivatives, and are used not only by the likes of banks and asset managers but also corporates and government authorities looking to hedge interest rate or foreign exchange exposures.
The reason why BMR matters so much to the rest of the world is because EU entities are major global investors and financial market participants.
However, few non-EU benchmark administrators are BMR compliant. What this means is that from 2020, if non-EU benchmark administrators are still not compliant, then EU-based entities will not be able to use them.
The EU-Asia Financial Services Roundtable believes that as many as 55 Asia-based financial benchmarks could be affected. In August 2018, it estimated that many of the major benchmarks, particularly those covering foreign exchange and interest rates, are widely used in Europe for swaps, derivatives and other structured products.
According to the Asia Securities Industry & Financial Markets Association (Asifma) there is now a very real risk that EU-based entities will be cut off from being able to use them because time is quickly running out to get them recognised
Why is it happening?
BMR was a response to the various market-rigging scandals that hit currency fixes and the interbank offered rates that emerged after the 2007-09 global financial crisis.
The International Organisation of Securities Commissions (Iosco) released its final report on principles for financial benchmarks in July 2013, designed to help regulators and benchmark providers develop robust methodologies and procedures for benchmarks. Naturally, the EU went further with BMR, which rather than being a set of principles is actually a set of rules governing benchmark administration in a jurisdiction where regulatory breaches can attract prison sentences.
What do bankers say?
Bankers understand the need for more robust benchmarks and within the EU most are getting on with making them compliant. But outside the EU, many are not even Iosco compliant, but are being used by EU-based entities.
There are routes for getting third-country benchmarks recognised in the EU, but unfortunately these are not very straightforward. The best one, equivalence, will not even be ready by 2020 as it still needs to be ratified by the European Council and European Parliament.
That leaves the ‘recognition’ or ‘endorsement’ route. In a nutshell, recognition requires a third-country-based administrator having EU representation, while endorsement involves third-country administrators needing to engage an authorised EU benchmark administrator to act on their behalf.
Superficially, endorsement looks the most attractive option, except that it leaves the EU benchmark administrator completely liable for any breaches by the third-country provider. Not many will want to take on this task and those that do will probably take an intrusive approach in the way that the provider runs their benchmarks.
Recognition involves substantial costs and establishing an EU reference country, plus some of the technical standards are still being honed by EU regulators.
At least six Asia-Pacific jurisdictions are putting in their own benchmark rules and hoping to gain EU equivalence rulings for their benchmark frameworks. But the coverage of those rules is patchy, and equivalence will take time to sort out – likely going beyond 2020.
Will it provide incentives?
BMR is yet another case of an extraterritorial regulation for which the US and, increasingly, the EU are becoming notorious. There is now a real risk that EU entities will not be able to access third-country benchmarks, which may mean certain financial products (whether these are regional funds or some swaps and other derivative products), cannot be sold, or that there are attempts to replicate some offshore benchmarks in less liquid and secondary EU financial markets with poorer quality reference rates.
It is also making benchmarks much more of a business, meaning that providers who previously did not charge for their use will now do so to compensate for the cost of making them compliant. Asifma believes this could lead to fewer providers and hence less choice and innovation.
Of course, this situation is complicated by the UK’s impending departure from the EU, creating confusion over where third-country providers register their benchmarks and even having to register them in both jurisdictions, raising costs still further.
BMR – for which there will be no implementation delays, according to EU authorities – risks creating yet another crack in global financial markets that are already under threat from fragmentation.
