Banks call for third-country benchmark fix as EC delays BMR

The European Commission (EC), which this week gave an extra two years to foreign benchmark providers to register their indexes in the trading bloc, should use the extension to tweak rules and ease the path to compliance, banks and industry groups say.

A major sticking point – the need for third-country administrators to field a legal representative in a member state – should be scrapped, they argue. Not only is the requirement hiking the cost of compliance, administrators such as Hong Kong’s Treasury Markets Association (TMA) are struggling to find a legal representative in the European Union.

The commission, which is the executive arm of the EU, extended compliance for critical and third-country benchmarks until the end of 2021, though its decision must still be approved by the European Parliament. The move comes as a relief to non-EU administrators, which were struggling to achieve recognition under the three options available. The UK’s impending exit from the bloc has complicated the process further. 

“The rules need to change,” says a regional regulation head at a European bank in Singapore. “If you cannot use any of the three paths available then logic says a change of the rules is needed.”

“They could remove the requirement for benchmark administrators to have a legal representative in Europe,” the regulation head adds. “Putting someone in the EU makes no sense for administrators of benchmarks that are predominantly used outside Europe.”

The EU Benchmarks Regulation (BMR) is intended to bolster the robustness of benchmarks and protect them from the type of manipulation that afflicted the London interbank offered rates. If a benchmark is not registered, European investors would be prohibited from buying or selling products referencing it, which could drive market fragmentation, leading to liquidity and hedging challenges.

Administrators currently have three options to ensure their benchmarks remain available for use by European firms under the regulation.

Regulators in so-called third-country nations can seek an equivalence decision to confirm their rules are aligned with those of the EU. Alternatively, administrators can obtain recognition from an EU member state. A third option allows non-EU benchmark administrators to receive an endorsement from an EU-regulated benchmarks provider.

If you cannot use any of the three paths available then logic says a change of the rules is needed

Regional regulation head at a European bank in Singapore

But each route has had its own challenges.

For a start, the EU has yet to determine any third-country’s benchmarks regulation equivalent, despite legislative efforts to establish comparable rules in Australia, Japan, Singapore, South Korea and India.

Meanwhile, the UK’s decision to exit the EU has spawned confusion around which national regulator benchmark administrators should approach for recognition. This leaves third-country administrators with the endorsement option, which many view as prohibitively expensive.  

“There is a general view that outside of an equivalence determination, the means to gain authorisation in the EU for third-country benchmarks – endorsement or recognition – are sub-optimal,” says John Ball, managing director for Asia-Pacific in the Global Financial Markets Association’s (GFMA) forex division.

As written, the regulation already provides scope for in-flight adjustments. Article 54(1) of the BMR requires the EC to review and submit a report to the European Parliament by January 2020 on the effectiveness of the rules, including the authorisation and registration regime. In light of the deadline extension, banks and industry representatives say now is the time to push through changes.

“Now, as the EU undertakes a review, there is an opportunity to work with administrators to identify a path for authorisation that is not as complex or as expensive as the existing options,” Ball adds.

Reducing prohibitive costs associated with recognition and endorsement routes should be a top priority, the European bank’s regulation head adds, given that some regulators – in emerging markets especially – will not consider equivalence under the BMR desirable or practical. “From a practical perspective not every country is going to institute a benchmark regime. In Thailand or the Philippines, for example, I would say the probability of that is quite low. But if there is no appetite to put in a regulation in your country there is currently no path left.”

The cost of compliance

Removing the BMR’s requirement for third-country benchmark administrators to have a legal representative in an EU member state would help to reduce the cost of compliance, says Will Hallatt, head of financial services regulation at Herbert Smith Freehills in Hong Kong.

“Cost has been the biggest factor because both recognition and endorsement would have required significant spend by third-country administrators on the services of a legal representative or endorsing entity,” says Hallatt. “In many cases, the business models of administrators would need to change substantially in order for the funding needed for compliance to be available.”  

GFMA’s Ball agrees that costs associated with recognition and endorsement may be deterring some benchmark administrators from seeking EU authorisation. These administrators, unlike their European and US peers, sometimes do not charge benchmark users and in many cases don’t even know who the users are. 

Finding a legal representative who will even accept the role is proving a tall order.

“We have had difficulty in finding a legal representative in the EU because individuals have personal legal liabilities under the BMR,” says Andy Ng, a senior manager at the TMA in Hong Kong who is responsible for benchmarks.

We have had difficulty in finding a legal representative in the EU because individuals have personal legal liabilities under the BMR

Andy Ng, Treasury Markets Association

The TMA is the administrator of two key interest rate benchmarks, the Hong Kong interbank offered rate and the Hong Kong dollar overnight index average, as well as two forex fixings, the USD/HKD spot rate and the USD/CNH spot rate. The group is yet to make a decision on which path to EU authorisation it will take. Ng emphasises that each of the three options have advantages and disadvantages.

For its part, the EU stresses the need for a local legal representative as it wants someone in the region to take responsibility and address any deficiencies in the benchmark.

However, the announcement of an additional two years for third countries to achieve authorisation gives benchmark users hope that the EC is listening to industry concerns and is prepared to act if necessary.

In November 2018, a briefing calling for the BMR transition period to be extended was co-authored by the Emerging Markets Traders Association, the Futures Industry Association, the the GFMA and the International Swaps and Derivatives Association.

Welcoming the EC’s acquiescence to the called-for extension for both critical and third-country benchmarks, Rick Sandilands, senior counsel for Europe at Isda, reasserts the need for more time. “The inclusion of non-EU benchmarks [in the BMR transition period] is important given the practical difficulties end-users would have faced due to issues associated with the qualification process for third-country benchmarks,” he says.