Fair and Effective Markets Review – Amendments to scope of UK benchmarks regulatory regime
Following the LIBOR manipulation investigation, the Financial Conduct Authority FCA and Prudential Regulation Authority PRA, took steps to develop and implement a supervisory framework for benchmark administrators and submitters. This has been effected by incorporating benchmark administration and submission of information into the UK’s regulated activities regime. On 2 April 2013, the following became regulated activities under Article 63O of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO):
- providing information in relation to a specified benchmark; and
- administering a specified benchmark.
Although initially driven by the issues resulting from the calculation and administration of LIBOR, benchmark regulation in the UK was designed to be widened in scope and to be applied in future to a more broad range of benchmarks.
On 12 June 2014 the Chancellor announced the Fair and Effective Markets Review (FEMR) to look into the way the wholesale markets operate. FEMR was expected to make recommendations on additional reforms in relation to benchmarks. In August 2014 FEMR provided to HM Treasury (HMT) recommendations on additional financial benchmarks to be brought into scope. The plan is essentially to extend the same powers put in place to regulate LIBOR to the following seven benchmarks across the foreign exchange, commodity and fixed income markets: Sterling Overnight Index Average (SONIA); Repurchase Overnight Index Average (RONIA); WM/Reuters’ FX benchmark rates (WMR); ISDAFix; ICE Brent Futures; LBMA Silver Price; and London Gold Fix.
HMT subsequently published a consultation paper (the CP) seeking views from interested parties on FEMR’s recommendations. These questions sought to determine, in addition to the costs and benefits of the proposed regulations, whether:
- FEMR were using appropriate criteria;
- the seven identified benchmarks met these (or other relevant) criteria;
- those benchmarks had any specific qualities that should be considered.
Impact of the recommendations
As a result of FEMR’s recommendations, a person carrying on either of the specified activities noted above, in relation to a specified benchmark, by way of business in the UK:
- must be authorised by the FCA, and will be subject to on-going regulatory compliance and supervision requirements; and
- will need to ensure that various members of staff become approved persons in accordance with the Statements of Principle and Code of Practice for Approved Persons (APER).
Whilst being designated as specified benchmarks introduces the risk of sanctions for administrators and information providers (and their Approved Persons), it does not give rise give rise to a right of action by a private person.
Furthermore, FEMR recommends that, in addition to being designated as specified benchmarks, the seven new benchmarks should also be designated as “relevant benchmarks”. Relevant benchmarks are subject to the regime under the Financial Services Act 2012 introducing new criminal offence of manipulating a relevant benchmark, either by (i) making misleading statements or (ii) by creating a false or misleading impression of the value of the investments that could affect such a benchmark. This regime is in addition to the FSMA regulatory regime governing specified benchmarks.
It is interesting to note that FEMR recommends that information providers should not be required to be authorised to conduct the regulated activity of ‘providing information in relation to a specified benchmark’ where they are providing purely factual information. FEMR envisages that it would be possible to submit purely factual information in respect of the WMR, ICE Brent Futures and LBMA Silver Price indices (and possibly also the London Gold Fix depending on how it is operated following its upcoming tender) but not the other three considered by FEMR. However, this exclusion is not currently part of the latest draft RAO amendment, so it is yet to be seen if this will be carried into the regime. Further, it is unclear whether this exclusion will apply to the criminal regime under the Financial Services Act 2012.
Overview for Benchmark Administrators and Benchmark Information Providers
The requirement to be authorised obliges administrators to be subject to certain rules. These include:
- implementing effective governance and oversight measures, including the establishment of an oversight committee and the development of practice standards in a published code;
- monitoring of benchmark submissions to identify irregularities in benchmark submissions and breaches of the practice standards and conduct that may involve manipulation, or attempted manipulation, of the benchmark;
- notifying the FCA of any suspicions in relation to the above;
- having arrangements in place to identify and manage conflicts of interest; and
- appointing a benchmark administration manager to oversee the firm’s compliance with the FCA’s requirements for benchmark administration.
Information providers will also be subject to similar requirements. These include:
- maintaining effective organisational and governance arrangements for the process of making benchmark submissions;
- having an effective methodology, based on objective criteria and relevant information, for determining their submissions to benchmarks (including keeping relevant records);
- notifying the FCA of any suspicions in relation to manipulation, attempts to manipulate, or potential collusion to manipulate the benchmark;
- having arrangements in place to identify and manage conflicts of interest; and
- appointing a benchmark manager to oversee the firm’s compliance with the FCA’s requirements for benchmark submission.
It is important to note that the requirements on information providers have extra-territorial effect where an information provider has an establishment in the UK, even where the submissions are made from outside the UK.
Other relevant regulatory requirements
New authorisations are required. For entities that are already subject to FCA (or PRA) authorisation, there is provision for their permissions to be automatically extended to cover the new regulated activities under Article 63O RAO. A variation of permission application will not be required. For entities that are not yet authorised, an interim permission to conduct the Article 63O RAO activities will be automatically granted. This interim permission will expire at the FCA’s determination.
Once authorised, the submitter will have to comply with all applicable FCA rules, including those relating to threshold conditions, conduct of business, the way the entity is organised and reporting. As an example, the applicant will be required to submit both financial and non-financial reports to the FCA on a periodic basis (monthly, quarterly, half yearly or annually depending on the type of business that the applicant proposes to conduct). An annual fee is payable to the FCA and additional contributions, to the financial services compensation scheme for example, may be required.
The main provisions are contained in the following FCA handbooks:
- The Principles for Business (PRIN), which sets out high level core obligations for authorised firms towards their clients and under the regulatory regime. Often, breach of one of the principles may be the basis of enforcement action by the FCA.
- Senior Management Arrangements, Systems and Controls (SYSC), which sets out the practical responsibilities for firm’s directors and senior managements to run an effective organisation , including having in place: appropriate governance, internal controls and organisational procedures; business continuity plans; accounting policies; audit committee; appropriate senior management responsibility; suitable compliance and financial crime procedures; risk controls; outsourcing procedures; record keeping procedures; and conflicts of interest procedures.
- Threshold Conditions (COND), which provides guidance on the location of offices, effective supervision, appropriate resources, suitability and the structure of the business model.
- General Provisions (GEN), which sets out information on interpretation of the handbook, approval by the UK regulator and status disclosures.
- Supervision (SUP), which sets out supervisory provisions including those relating to auditors, waivers, individual guidance, notifications and reporting.
- It should also be noted that various senior persons at the administrating or submitting entity would also have to become approved persons in order to administer the benchmark administration activities appropriately. These persons will be subject to the FCA rules contained in APER. The following controlled functions will be necessary: CF1 – Director; CF2 – Non-executive director; CF3 – Chief executive; CF10 – Compliance officer; CF11 – Money laundering officer; and CF50 – Benchmark administrator manager (administrators only) / CF40 – Benchmark manager (information providers only).
View HMT’s consultation, FEMR’s recommendations and the draft legislation, 25 September 2014