Benchmark Regulation: Are you meeting your responsibilities?

March 28, 2022 by Clementine Bowyer

Introduction 

Over the course of my career, I have worked in companies which have either produced, contributed to or relied upon Benchmarks, and have been a member of several in-house and external Benchmark Committees. The overwhelming issue which I have seen a number of Firms struggle with is data governance, specifically having the right infrastructure in place to ensure Firms can identify what data they issue to third parties and for what purpose it is used.

There is often a misconception in the market that Benchmark Regulation only applies to Firms which Administer or formally contribute data to registered Benchmarks. This is not accurate. Firms have a responsibility to know the use of all the data they issue to third parties and to ensure it is properly governed and auditable.

The below article provides some background and detail on the Benchmark Regulation in the UK and Europe. This is by no means an exhaustive list of considerations and if Firms would like to discuss what this Regulation means to their specific business, please do contact me on cbowyer@effectacompliance.com.

Background 

The LIBOR and EURIBOR scandals have resulted in significant changes being made across Europe and the UK with regards to the regulatory oversight of Benchmarks, most recently demonstrated by the planned transitions away from IBORs towards Risk Free Rates (RFRs).  

However, whilst the recent drive towards less risk-based Benchmarks has been at the forefront of the Regulators agenda on Benchmark reform, companies should not forget the ongoing requirements of the UK Benchmark Regulation and ensuring their businesses are in compliance. 

Given UK entities have now been subject to the Benchmark Regulation for over 4 years, the FCA expects entities to have fully embedded the requirements of the Regulation and to have developed robust frameworks to both monitor existing benchmark related activities and to identify and prevent any new activity which could fall under the Regulation.  

The Regulation 

The EU Benchmark Regulation came into force in January 2018 with the aim of ensuring a consistent approach to the governance and oversight of Benchmarks across the European Union. 

Whilst the UK has now departed from the EU, the FCA transposed the EU Benchmark Regulation into UK law at the end of the transitional period and, although the UK has made steps to bring about some changes to the UK version of the Benchmark Regulation, the regime around the governance and regulation of Benchmarks in the UK remains at present largely unchanged since its departure from the European Union.  

Who is impacted? 

Any entity in the UK that is involved in any of the following activities will be directly impacted by the Benchmark Regulation and will have requirements to either become authorized with the FCA or to follow the prescribed governance and oversight responsibilities contained in the Legislation: 

  • A company which either calculates or provides Benchmarks to the market (Benchmark Administration/Calculation Agent Activities) 
  • A company which provides data to a third party specifically for the purposes of calculation of a Benchmark (Data Provision/Supervised Contributor Activities) 
  • A market participant who uses a Benchmark to determine the amount payable under a contract or to value a financial instrument or the performance of an investment fund (Benchmark User) 

Whilst on the face of it, the categorization of these activities appears quite clear, the type of activity which can indirectly fall within each of the definitions is actually very broad. Perhaps most significant is the expectation for businesses to know the use of all data they provide to third parties, with the FCA being very clear it is not a defence to state you did not know your data was being used for Benchmark purposes. In essence, firms can no longer rely on third parties to inform them if they are using their data for such purposes. They should proactively find out from their clients what their use is.

What is a Benchmark? 

Perhaps the biggest impact of the EU Benchmark Regulation was the significant expansion it made to the definition of what can constitute a Benchmark. No longer are Benchmarks limited in scope to those which are critical and known to the market (such as LIBOR, EURIBOR).  

Instead, a Benchmark is now defined as any ‘index’ which is used to value or determine the amount payable under a financial instrument or contract, or to measure the performance of an investment fund with an ‘index’ being defined widely as any figure which: 

  • Is published or made available to the public; 
  • Is regularly determined by the application of a formula or any other method of calculation (this is not automated only but can include repeat manual parameters) 

Under this widened definition, any business which is providing clients (for example via an external facing screen) with a calculated figure which is then used by the market for pricing or valuation purposes could now meet the definition of being a Benchmark Administrator and require authorization. Again, it is not a defence for a firm to state they weren’t aware their indices were being used in such a way, with the burden of responsibility falling on the issuers to know the use of their index. 

Consequently, any Firms not authorized as Benchmark Administrators, but which are publishing indexes should ensure robust controls are in place to prevent clients/third parties from using the levels for market pricing and valuation purposes (as detailed above).  

Provision of Data to a Benchmark 

Any entity which provides non-public data to a third party for the purposes of Benchmark Calculation would be considered a ‘Contributor’ under the Regulation and is subject to a number of prescribed responsibilities. ‘Contributors’ must adhere to a Benchmark Administrators Code of Conduct and conduct annual reviews of their systems and controls to ensure they remain effective. 

However, the regulatory landscape is not limited to ‘Contributors’. Any entities which provide data to a Benchmark Administrator, even where it is public information and therefore does not make the entity a ‘Contributor’ under the Regulation, are expected to ensure the data provided to a third party is accurate and verifiable. 

Consequently, entities should ensure they have a control framework in place which identifies where data is provided to third parties, and further verify and test their systems and controls to ensure adequate quality assurance and market abuse checks are being conducted on the data. 

Summary 

The market has seen firsthand the impact of reference rates being manipulated, or not reflective of the actual market. The Benchmark scandals highlighted how critical each part of the process is in ensuring rates which are relied on in the market are accurate. The Regulation aims to address this and has moved the landscape away from only focusing on traditional Benchmarks and their Administrators. Instead, any UK entity involved in the creation of a Benchmark is now touched and the Regulators expectations around firms understanding the use of their data is clear. 

How Effecta can Help: 
  1. Independent Reviews: For those Firms which have already identified they are conducting Benchmark related activities, Effecta can conduct independent reviews and audits of your control frameworks to ensure they are adequate to meet your regulatory responsibilities. For example:
  2. Benchmark Administrators: Entities which are authorised as a Benchmark Administrator with the FCA will need to conduct regular & independent reviews of their systems and controls to ensure they remain effective.  
  3. Supervised Contributors: Entities which are Contributors will need to conduct annual reviews of their processes both to test the robustness of their controls and data accuracy, and to demonstrate to their Administrator that they are meeting the requirements contained in their Code of Conduct.  
  1. Deep Dives: For those Firms which have not conducted a deep dive into the Benchmark Regulation, Effecta can assist your firm with conducting an audit or deep dive of your current business to identify any Benchmark Activities 
  2. Monitoring: Effecta can undertake a review of your quality assurance and market abuse monitoring to assess whether they are sufficient to monitor and detect Benchmark Manipulation through your firm. 
  3. Advice: Effecta can provide ad hoc compliance support and guidance on Regulatory matters.