On 9 March 2020, the European Securities and Markets Authority (ESMA) launched a public consultation on new draft Regulatory Technical Standards (RTS) under Regulation (EU) 2016/1011 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds (“European Benchmark Regulation” or BMR). This new draft RTS follows the adoption of targeted amendments to the BMR as introduced by Regulation (EU) 2019/2175 on review of regulations establishing the European Supervisory Authorities (“ESAs Review Regulation”). The consultation paper consists of five chapters and covers provisions addressing governance, methodology, infringements reporting and critical benchmarks.
Key points to note:
- Governance arrangements (Article 4 BMR)
ESMA was mandated to develop draft RTS to specify the requirements to ensure that the governance arrangements are “sufficiently robust”. The draft RTS includes provisions on organisational structure, roles and responsibilities for persons involved in the benchmark administrators’ governance arrangements and additional transparency provisions. In respect of the organisational structure, ESMA proposes that such structure should clearly and in a documented manner specify decision-making procedures, reporting lines that allocate “unambiguously functions and responsibilities and ensuring accountability for the decisions taken regarding the provision of benchmarks”. The relevant persons involved in the benchmark administrators’ governance arrangements must be “aware of the responsibilities that are allocated to them and the procedures that must be followed for the proper discharge of these responsibilities”.
- Methodology (Article 12 BMR)
The ESAs Review Regulation mandated ESMA to develop draft RTS to specify the conditions to ensure that the methodology is robust and reliable, has clear rules identifying how and when discretion may be exercised, is rigorous, continuous and capable of validation, is resilient and “ensures that benchmarks can be calculated in the widest set of possible circumstances” and is traceable and verifiable. The draft RTS includes provisions addressing each of these points. In respect of the requirement for the methodology to be “rigorous”, ESMA proposes – among others – that the methodology includes an assessment of the adequacy and appropriateness of the historical values of the benchmark, as well as “reliable inputs, including the appropriate size of the data samples”. It also proposes the introduction of rules addressing ex-post back-testing the methodology. In respect of the benchmark methodology being “resilient”, ESMA proposes to introduce an obligation to conduct de facto “stress tests” (“assessing the impact of the benchmark’s methodology of various market conditions using historical data from realised stressed market conditions and hypothetical data for unrealised stressed market conditions”).
- Reporting of infringements (Article 14 BMR)
ESMA was mandated to develop draft RTS setting out the characteristics of the systems and controls that a benchmark administrator has to have in place in order to ensure the integrity of input data and to report to the competent authority any conduct that may involve manipulation or attempted manipulation of a benchmark under Regulation (EU) 596/2014 on market abuse. To this end, the draft RTS includes provisions on adequate systems and effective controls to ensure the integrity of input data, provisions on benchmark manipulation risk assessment, the process to notify the oversight functions as well as rules relating to staff training and data integrity policy. The draft RTS specifies that the relevant systems and procedures must be “appropriate and proportionate in relation to the nature, scale and complexity of the benchmark provision” and that the administrators should carry out an assessment of the risks of manipulation of the benchmark while “referring to the features of the benchmark”. In the case of when a “reasonable suspicion that a benchmark manipulation as occurred”, ESMA proposes a procedure setting out steps for notification to the benchmark oversight function of the prospective breach. ESMA also proposes that the administrator should organise and provide “effective and comprehensive” training to the staff that focuses on detection and identification of suspicious data. Finally, ESMA suggests an introduction of an obligation for benchmark administrators to adopt and maintain a dedicated data integrity policy.
- Mandatory administration of critical benchmarks (Article 21 BMR)
The draft RTS seek to specify the criteria on which the assessment on how the critical benchmark is to be transitioned to a new administrator or to be ceased to be provided. In terms of criteria for the assessment on the transition to a new administrator, ESMA proposes – among others – to consider whether the proposed new administrator is located in the same Member State as the current one, whether it is a supervised entity and is an authorised or registered benchmark administrator, the way in which the new administrator intends to calculate the benchmark and whether it intends to amend any of the existing procedures (such as the methodology, code of conduct, etc). It also proposes to consider legal risks involved in the transition, the existence of any detailed plan for the switch date, and the new administrator’s access to the relevant input data. In respect of the assessment on the cessation of the provision of a benchmark, some of the criteria being considered include the effectiveness and appropriateness of the procedures for the benchmark cessation, including detailed actions and steps set out therein, the volume and value of financial instruments, financial contracts and the investment fund referencing the critical benchmark in question, as well as the term, duration, and maturity of expiry date of any such instruments. It also proposes to consider the existence of any alternative benchmarks, as well as the analysis as to whether the cessation of the benchmark would have an adverse impact on “market integrity, financial stability, consumers, the real economy, or the financing of households and businesses in the EU” and any legal risks involved.
- Non-significant benchmarks (Article 26 BMR)
ESMA was mandated to develop draft RTS to specify the criteria under which Member State competent authorities may require changes to the compliance statement. In particular, the draft RTS includes proposed provisions on the relevant criteria at the level of the administrator and criteria at the level of the benchmark. The former includes issues such as the organisational structure of the administrator and the potential conflicts of interest, the process of overseeing the provision of the benchmark and the control framework for the provision and publication of benchmarks. In respect of the criteria at the level of the benchmark, the draft RTS lists issues such as the level of control relating to the provision of input data to ensure the accuracy and integrity of input data, the relevant elements of the code of conduct, the process for reviewing of methodology and the transparency of the procedures for consulting on any material change of the methodology.
Stakeholders have until 9 May 2020 to provide feedback, following which ESMA expects to publish a final report and submit the draft RTS for endorsement to the Commission by 1 October 2020. This workstream takes place in parallel to the broader review of the BMR that is currently being undertaken by the European Commission (see our blog post).