BMR and the Third Country Regime

The European Commission announced last week that the Parliament and Council had reached a political agreement to extend the transitional deadline for third country benchmarks to become compliant with EU Benchmark Regulation ("BMR"). The extension was agreed as part of the broader "low carbon" proposal intended to stimulate investment in sustainable assets. While the agreement still needs to be adopted into law, it was intended to respond to concerns by the industry over the potential for disruption should certain foreign benchmarks be restricted from use in financial contracts. A valid concern given the relatively short remaining time period and given so few third country benchmarks have been admitted to the ESMA register.

While the extension was a welcome relief for benchmark users, some administrators have expressed concerns that this extension disadvantages EU administrators who have already made significant investment in BMR compliance and are held to a higher standard, particularly the investable indices which are provided by financial institutions to support the issuance of financial products. Many others query how the extended transitional period will be effective given the challenges associated with BMR adoption outside of the EU.

On 31 January 2019, IHS Markit hosted a workshop with the European Commission ("EC"), the FCA, ESMA, the Netherlands Authority for the Financial Markets and key industry stakeholders. The aim was to surface and discuss the challenges that benchmark administrators outside the EU face in achieving compliance with BMR to ensure continuity beyond the transitional period - whether that be 2020 or 2022.

The discussion centered around concerns about the lack of preparation by third country benchmark providers and the continued lack of approved third country benchmark administrators on the ESMA Register. Participants were clear that confusion in interpreting BMR; obligations and expectations on third country administrators; and a lack of clear tangible steps needed to obtain recognition and endorsement have all contributed to these concerns. The following summary highlights the key conclusions reached during the discussion which we are publishing to help provide guidance for third country administrators.

Summary of Roundtable Conclusions

1. Users and administrators should ensure that they start preparations early in advance of BMR timelines. The EC will continue to commit significant resources into preparing equivalence assessments. While the proposed amendment to BMR for low carbon benchmarks includes an agreement to extend the transitional period for EU critical benchmarks and third country benchmarks by two years until 31 December 2021, many equivalence decisions may still not be possible even within this timeframe and will not extend beyond critical or regulated benchmarks in each equivalent jurisdiction.
2. The EC is advancing its work on equivalence for a series of Asia-Pacific jurisdictions which have adopted, or are in the process of adopting, rules on the administration of benchmarks. Such rules form the foundation of an equivalence assessment. It should be noted that all equivalence proposals have to be endorsed by a qualified majority of EU Member States. While equivalence will hopefully provide solutions for some jurisdictions, coverage cannot be comprehensive and so the equivalence decisions are likely to cover only regulated benchmarks with systemic importance. There will be countries that cannot be covered. Therefore, it is important to consider all the options open for third country benchmark administrators foreseen in the BMR, including recognition and endorsement. Work is ongoing on these elements of the BMR by regulators and industry.
3. The EC acknowledged the challenges associated with recognition and endorsement, but indicated that endorsement, in particular, could play a significant role in ensuring robust third country benchmarks remain available to EU users. The benefits of an independent audit by a reputable accountancy firm alongside an ongoing endorsement by a knowledgeable and experienced EU supervised entity were clearly noted. The participants noted a number of organisations offering such services, including the host IHS Markit, who confirmed their intent to provide endorsement services. However, it was agreed that some uncertainties remain where a better shared understanding would be beneficial to the development of such services.

Further to above, the discussion also considered that:

• Given that potential equivalence decisions are likely to be limited and focused largely on regulated benchmarks of systemic importance, the general recommendations of the roundtable to third-country administrators were to seek endorsement or recognition arrangements as a first priority to ensure they can continue servicing their EU customers post January 2022.
  
  
• Endorsement should be a primary consideration for third country administrators, particularly where uncertainty around the member state of reference exists;
  
  
• The EC was confident that, by applying best industry practice, EU benchmark administrators would be well placed to provide endorsement solutions, and thus it supported and encouraged such efforts.
  
  
• The role of the endorser should be proportionate and risk-based to apportioning liability, focusing on its responsibility to assure compliance with the relevant BMR standards and the third country administrator's compliance with the IOSCO Principles;
  
  
• While BMR allows for any 'supervised entity' to act as endorser, in practice the role would be expected to fall to an entity already approved as an EU benchmark administrator;
  
  
• Regulators expressed that industry expertise and best practice should be allowed to shape how endorsement will work. Drawing on the experience of the attendees, examples of such a role can include:
  
  
  • Ensuring the appropriate accountability, control and governance arrangements are in place and being adhered to;
  • The ability to participate in or influence, in a balanced manner, matters of governance;
  • Being able to monitor any potential compliance gaps or risks identified through the due diligence or monitoring process; and
  • Having mechanisms to terminate the relationship and inform the competent authority and/or ESMA if the administrator fails to address concerns in the appropriate time or the endorser no longer has confidence that the required standards are being maintained.
• BMR clearly intends to respect the IOSCO Principles as the global standards while also ensuring that their flexibility does not lead to lower standards. To ensure this, the EC highlighted that an endorser could, for a third country administrator complying with the IOSCO Principles, draw heavily on the external auditor's report alongside its own assessment, to ensure that the application of the IOSCO Principles does not fall short of BMR requirements (for example, through an intensive use of proportionality or exemptions).

Posted 07 March 2019 by David Cook, Executive Director, Regulatory Affairs

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