EU Benchmark Regulation now in force; transitional dates determined

Key points

"Made available to the public". An "index" is any figure that is, amongst other things, "published or made available to the public". ESMA proposes that this phrase should be interpreted very broadly, such that:

• even if an index is only licensed to a single user, if that user makes the index available to an indeterminate number of people, it has been "made available to the public";
• the index will be available to an indeterminate number of people through the "dissemination of such index values […] through their incorporation into the coupons, strike prices, differentials, and values of financial instruments and investment funds referencing it, as the investor can isolate the index value therefrom". Therefore, it appears that publication not only of the index value, but also of the value of the listed financial instrument which references the index or even certain elements of the payout formula linked to the performance of the index will satisfy this criterion; and
• the methods of publication and rights of access do not need to be the same for all recipients/users – e.g. charging an access fee is not relevant when determining whether or not an index has been made available to the public.

Non-compliant benchmarks. ESMA proposes that the use of non-compliant benchmarks which existed on 30 June 2016 should be permitted until 1 January 2020 but that, thereafter, their use should only be permitted if ceasing to provide them or changing them to ensure compliance would (i) result in force majeure or (ii) frustrate or otherwise breach the terms of any financial contract or financial instrument or the rules of any investment fund referencing them (see Transitional provisions below). ESMA also proposes a list of criteria which competent authorities should use when making such a determination, to ensure a consistent approach (see Force Majeure, Frustration, Breach below).

Third country benchmarks. Absent any equivalence decision, recognition of the administrator or endorsement of the benchmark, third country benchmarks which are already used in the EU may continue to be used, but only in respect of financial contracts, financial instruments or investment funds which referenced them prior to 1 January 2020.

Authorisation deadline. Index providers have until 1 January 2020 to apply for authorisation or registration and may continue to provide benchmarks unless and until their application is rejected. Index providers which do not apply may only provide existing benchmarks until 1 January 2020.

Critical benchmarks. The regime for critical benchmarks applies from 30 June 2016.

key terms
Benchmark	Any index by reference to which the amount payable under a financial instrument or a financial contract, or the value of a financial instrument, is determined, or an index that is used to measure the performance of an investment fund.
Index	Any figure: that is published or made available to the public; that is regularly determined, entirely or partially, by the application of a formula, other method of calculation, or assessment; and where this determination is made on the basis of the value of one or more underlying assets or prices, including estimated prices, actual or estimated interest rates, quotes and committed quotes, or other values or surveys.
Finanical instrument	Any instrument listed in Annex I(C) to MiFID that is either: the subject of a request made for admission to trading on a trading venue; or traded on a trading venue.
Financial contract	Consumer credit agreements; and residential mortgage agreements.
Investment fund	AIFs; and UCITS

The EU regulation on indices used as benchmarks in financial instruments and financial contracts ("Benchmark Regulation") entered into force on 30 June 2016. Subject to various transitional provisions (see Transitional provisions below), it will apply from 1 January 2018.¹

ESMA is required to provide technical advice to the European Commission and has been consulting on technical standards covering the following topics, which are discussed in this briefing.

The consultation period was very short (one month) and has now closed (on 30 June 2016). A second consultation paper on technical standards is due to be published in the second half of 2016.

Meaning of key terms

"Made available to the public"

ESMA is proposing that an index should be deemed to be "made available to the public" if:

• it is accessible by a large or potential indeterminate number of recipients; or

• it is provided or is accessible to one or more supervised entities to allow the use of the index and through such use the index becomes accessible to an indeterminate number of people.

There is no guidance at this stage as regards what amounts to "large" or "indeterminate". 

ESMA is proposing the adoption of the broadest possible meaning of "made available to the public". For example, it is proposing that:

• even if an index is only licensed to a single user, if that user makes the index available to an indeterminate number of people, then it has been "made available to the public";
• an index will be made available to an indeterminate number of people where it is referenced in a financial instrument or investment fund which is listed on a regulated market, and the value of the financial instrument or investment fund is published, because the investor is able to establish the index value from this information;
• even if only "coupons, strike prices [and] differentials" are published, this will be sufficient to cause the index value to be "made available to the public" for the same reasons given immediately above. Thus ESMA is apparently saying that even if the index value itself is not published, but other values in the payout formula are, this may be sufficient to cause the index value to have been "made available to the public";
• as the values of certain derivatives and UCITS funds must be published in accordance with MiFIR and UCITS, respectively, the criterion of being "made available to the public" should in nearly all cases be met by such products; and
• for structured securities, where a value (for example, the bid/offer price) is being published, it would appear that ESMA would regard that as making the reference index available to the public.

ESMA proposes that the mode of publication (which may be set out by the administrator or agreed between the administrator and the users) and the requirement or otherwise to pay an access fee should be irrelevant, as should whether the frequency of publication of the index value is consistent with the frequency by which the level is calculated.

The effect of these proposals would be that, even if an administrator licenses only a single user of a product to use its index (as is often the case for a "proprietary" or "custom" index), that index will still most likely be regarded as being "made available to the public" where it is referenced in a financial instrument listed on a regulated market where values of that instrument are regularly published.

ESMA justifies its proposed approach by referring to Recital 8 of the Regulation, which states that the scope of the Regulation should be as broad as necessary to create a preventative regulatory framework. It also wants to avoid administrators taking indices out of scope of the Regulation by restricting access.

Where an index becomes accessible "second-hand" after provision to a supervised entity by an index provider, industry bodies intend to request clarification from ESMA that the defence provided under Article 2(2)(h) of the Benchmark Regulation will be available. This Article exempts from compliance any index provider which is not aware and which could not reasonably have been aware that an index was within scope as a result of its onward use.

"Administering the arrangements for determining a benchmark"

The Benchmark Regulation imposes certain obligations on administrators of benchmarks – that is, any natural or legal person that has control over the provision of a benchmark. Under the Benchmark Regulation, "provision of a benchmark" means:

• administering the arrangements for determining a benchmark;
• collecting, analysing or processing input data for the purpose of determining a benchmark; and
• determining a benchmark through the application of a formula or other method of calculation or by an assessment of input data provided for that purpose.

Given the variety of business models employed for the provision of benchmarks, ESMA is seeking to clarify what "administering the arrangements" means. It is proposed that the "administration of the arrangements for the determination of a benchmark" should mean:

• the on-going management of the infrastructure and of the personnel that are involved in the determination process of a benchmark; and
• the setting of a specific methodology for the determination of each benchmark or, with the necessary adaptations, each family of benchmarks provided, and its maintenance through periodic reviews.

"Issuance of a financial instrument"

Obligations are also imposed by the Benchmark Regulation in respect of the "use of a benchmark", which is defined as including "issuance of a financial instrument which references an index or a combination of indices".

ESMA is proposing that a reference to the "issuance" of a financial instrument referencing an index or a combination of indices should be interpreted as a reference to the initial offering of:

• transferable securities (shares, bonds and other forms of security);
• money-market instruments; and
• units in collective investment undertakings,

to third parties, through negotiation on trading venues and/or systematic internalisers.

The adoption of this proposal would exclude derivatives, the rationale being that they are not "issued". Derivatives would, however, be caught under a separate limb of the definition of "use of a benchmark", which includes "determination of the amount payable under a financial instrument […] by referencing an index or a combination of indices".

Measurement of reference value of critical and significant benchmarks

The Benchmark Regulation contains certain provisions which are applicable to "critical" and "significant" benchmarks. Quantitative thresholds are set out in the Benchmark Regulation to help determine whether a benchmark falls within one of these categories. ESMA is consulting on the appropriate methodology for calculating the following, for use in determining whether a benchmark meets these thresholds:

• the nominal amount of financial instruments other than derivatives;
• the notional amount of derivatives; and
• the net asset value of investment funds.

Direct reference to a benchmark

Where there is a direct reference to a benchmark, ESMA is proposing that the following be taken into account when assessing whether it is "critical" or "significant" (or neither):

• for bonds, money-market instruments and other forms of securitised debt including structured finance products, the total issued nominal amount (in EUR) thereof referencing the benchmark, as reported under the EU markets in financial instruments and amending regulation (MiFIR);

• for derivatives, the notional amount as reported under the European Markets and Infrastructure Regulation (EMIR), except that:

• if the notional amount is negative, the absolute value should be taken into account;
• for credit derivative index transactions, the notional amount should be applied to the index factor; and
• additional measurement methods should be used for certain categories of derivatives;

• for UCITS, the latest available net asset value per unit, as reported in the most recent annual or half-yearly report; and
• for AIFs, the latest available net asset value per unit, multiplied by the number of units.

If the required data is not available or not sufficient, proxies for the values may be used, such as open interest data, as reported by alternative private providers of information available to administrators and competent authorities.

ESMA is proposing that calculations made in respect of significant benchmarks be calculated over a period of six months to ensure that a representative figure is achieved and to avoid over-valuation. However, calculations in respect of critical benchmarks are proposed to be made at a specific point in time, as such benchmarks are by definition so widely used that they are less subject to fluctuations. The intention is to help simplify the calculation process and reduce costs.

Indirect reference to a benchmark within a combination of benchmarks

Where reference to a benchmark is indirect, within a combination of benchmarks, the following should be taken into account (in EUR):

• if the weighting of the benchmark in question within the combination of benchmarks is known, the portion of the notional amount, nominal amount or net asset value, as applicable, indirectly referencing the benchmark; or
• if the weighting of the benchmark in question is not known, the portion of the total notional amount, nominal amount or net asset value, as applicable, indirectly referencing such benchmark, assuming an equally weighted combination of benchmarks.

Identification of critical benchmarks

The Benchmark Regulation sets out certain criteria which, if met, indicate that a benchmark should be considered "critical". The European Commission is required to review the list of critical benchmarks at least every two years. To be considered critical, a benchmark:

• must be recognised as being critical in a particular Member State and be based on submissions by contributors mostly located in that Member State; or
• must be used, directly or indirectly, as a reference for financial instruments or financial contracts or for measuring the performance of investment funds, in each case having a total value of at least €500 billion (see Measurement of reference value of critical and significant benchmarks above); or

must:

• be either (i) used as a reference, directly or indirectly, for financial instruments or financial contracts, or for measuring the performance of investment funds, in each case having a total value of between €400 billion and €500 billion (see Measurement of reference value of critical and significant benchmarks above); or (ii) designated as "critical" by the competent authorities of the applicable EU Member States;

• have no or very few appropriate market-led substitutes; and

• be of such importance that ceasing to provide it, or providing it on the basis of unrepresentative data, would have a significant and adverse impact in one or more Member States on:
• market integrity;

• financial stability;
• consumers;
• the real economy; or
• the financing of households and businesses.

ESMA is consulting on how the third bullet point above should be analysed, and whether numerical measures could be developed to ensure objective consideration of the five elements to be taken into account when determining whether there has been "a significant and adverse impact". A non-exhaustive list of criteria (see Proposed criteria for identification of critical benchmarks below) has been proposed by ESMA, which should be taken into account when determining whether there has been "a significant and adverse impact"; these should be considered jointly to allow an "holistic" analysis of the benchmark and any assessment should indicate which criteria have not been considered and why.

Proposed criteria for identification of critical benchmarks

Market integrity

• The value of financial contracts, financial instruments or investment funds that reference the benchmark, directly or indirectly, in the Member State(s) considered and whether this is a significant share of the total value of such products outstanding in such Member State(s).
• Whether the benchmark is considered or used as a potential successor for other critical benchmarks.
• The diversity of financial instruments and financial contracts referencing the benchmark, and in particular:

• the number of different types of derivative contracts that reference the benchmark in the Member State(s) considered;
• the reference of the benchmark simultaneously in derivatives, securities, investment funds and financial contracts; and
• the average and maximum tenors of the existing financial instruments and financial contracts referencing the benchmark.

• The use of the benchmark as a standard for accounting purposes or as a reference for other regulatory purposes and in particular:

• whether the benchmark is used as a reference for prudential regulation such as capital, liquidity or leverage requirements;
• whether the benchmark is used in international accounting standards; and
• whether the benchmark is used for tax purposes.

Financial stability

• The value of financial instruments, financial contracts and investment funds that reference the benchmark, directly or indirectly, in the Member State(s) considered and whether this is a significant share of:

• the total assets of the financial sector in such Member State(s); and
• the total assets of the banking sector in such Member State(s).

Consumers

• The use of the benchmark in financial instruments and investment funds offered to retail investors, and in particular:

• the value of the financial instruments and investment funds referencing the benchmark, directly or indirectly, sold to retail investors in the Member State(s) considered and whether this is a significant share of the total value of financial instruments and investment funds sold to retail investors in such Member State(s); and
• an estimate of the number of retail investors who have bought financial instruments and investment funds referencing the benchmark, directly or indirectly, in the Member State(s) considered and whether this is a significant share of the total population in such Member State(s).

• The use of the benchmark by pension funds, and in particular:

• the value of pension funds referencing the benchmark for measuring their performance in the Member State(s) considered and whether this is a significant share of the total value of the pension funds in such Member State(s); and
• an estimate of the number of consumers participating in pension funds referencing the benchmark for measuring their performance in the Member State(s) considered and whether this is a significant share of the total population in such Member State(s).

Real economy

• The value of financial instruments, financial contracts and investment funds that reference the benchmark, directly or indirectly, in the Member State(s) and whether this is a significant share of the gross national product of such Member State(s).

Financing of households and businesses

• The use of the benchmark in loans, and in particular:

• the value of loans to households and non-financial corporates referencing the benchmark in the Member State(s) considered and whether this is a significant share of the total value of loans to households or non-financial corporates in such Member State(s);
• an estimate of the number of households that have subscribed loans referencing the benchmark in one or more Member States and whether this is a significant share of the total number of households in such Member State(s); and
• an estimate of the number of non-financial corporates that have subscribed loans referencing the benchmark in one or more Member States and whether this is a significant share of the total number of non-financial corporates in such Member State(s).

Endorsement of third country benchmarks

Under the Benchmark Regulation, the use by EU entities of third country (non-EU) benchmarks is possible via three avenues:

• the applicable regime having been granted EU equivalence status and entered into a cooperation agreement;
• recognition of the benchmark by the applicable Member State national authorities pending receipt of equivalence status; and
• endorsement of the benchmark by an EU administrator

(see our previous briefing for more information about these options).

In order for the third option above to be used, certain conditions must be fulfilled. One of these is that the administrator applying for endorsement must demonstrate that there is an objective reason (i) to provide the benchmark or family of benchmarks in question in a third country, and (ii) for the benchmark or family of benchmarks to be endorsed in the EU. ESMA is consulting on measures to determine how competent authorities should assess whether conditions (i) and (ii) have been met.

ESMA proposes that the following non-exhaustive list of factors be taken into account when considering an application for endorsement.

Objective reasons for the provision of a benchmark or family of benchmarks in a third country

Geographical proximity

• The market it is intended to measure is geographically limited to a certain region and the benchmark provider is closely linked to that market;
• where the benchmark is based on contributions, the contributors are all, or in majority, located in the same non-EU region of the provider;
• a large existing portion of subscribers to the benchmark is located outside the EU; and
• the third country provider can access the infrastructure available in the non-EU region exclusively or can maintain systems necessary for administering the benchmark only locally.

ESMA suggests that the following conditions should strengthen an applicant endorser's claim:

• the provider of the third country benchmark is not likely to apply for recognition, particularly if benchmark provision is only an ancillary activity to its core business; or
•  the benchmark may not be provided by an administrator in the EU, including for technical reasons or, in exceptional cases, a different time zone; or
• providing the benchmark geographically near the market it is intended to measure leads to a reduction in costs and this is directly and significantly advantageous to the benchmark users.

Specific skills required in the benchmark provision

• The benchmark relies partly on the expertise of individuals/firms located in the third country and this expertise is based on individual experience and/or personal skills that are associated with employees of the third country benchmark provider or third country contributors.

ESMA suggests that the following conditions should strengthen an applicant endorser's claim:

• the relevant personnel within the third country provider or, more generally, the third country provider itself, would not want to or is otherwise prevented from providing its expertise to an entity in the EU; or
• relying on the individual experience and/or personal skills of the employees of the third country benchmark provider for the provision of the benchmark leads to reduction of costs and that this is directly and significantly advantageous to the benchmark users.

Legal or other restraints to obtain input data

• The benchmark is based on third country input data and the necessary data cannot be submitted to an administrator in the EU to be processed for a provision in the EU because of legal, contractual, corporate constraints that extend beyond the individual contractual situation of the input data contributors/submitters.

Objective reasons for the use of a third country benchmark or family of third country benchmarks in the EU

• If the lack of endorsement of a third country benchmark for use in the EU would have adverse consequences in the EU, according to ESMA, this suggests that there is an objective reason for the use of that third country benchmark in the EU.

ESMA suggest that the following conditions should strengthen an applicant endorser's claim:

• the third country benchmark is often used in the EU and there are no substitutes available in the EU; and

• the discontinuation of the use of the third country benchmark would adversely and materially affect users of the benchmark in the EU or adversely affect the financial stability or market integrity of the European area in which it is already used, or the consumers, the real economy or the financing of households and businesses in that area.

Transitional provisions

Authorisation deadline: any index provider providing a benchmark when the Benchmark Regulation came into force on 30 June 2016 must apply for authorisation or registration under the Benchmark Regulation by 1 January 2020. The index provider can continue to provide existing benchmarks unless and until its application is refused. If no application is made by the index provider, it may only continue to provide an existing benchmark until 1 January 2020.

Non-compliant benchmark: the Benchmark Regulation provides that, if an existing benchmark is non-compliant (a "non-compliant benchmark"), its continued use is permitted only if the relevant competent authority of the Member State where the provider is located determines that ceasing or changing that benchmark to conform with the requirements of the Benchmark Regulation would (i) result in a force majeure event or (ii) frustrate or otherwise breach the terms of any financial contract or financial instrument or the rules of any investment fund referencing that benchmark².

ESMA has proposed a change, such that that the use of a non-compliant benchmark "existing" on 30 June 2016 is permitted generally until 1 January 2020 but that, thereafter, its use should only be permitted if ceasing to provide it or changing it to ensure compliance would (i) result in force majeure or (ii) frustrate or otherwise breach the terms of any financial contract or financial instrument or the rules of any investment fund referencing it. The interpretation which ESMA proposes to take as to "existing benchmark" – i.e. that this refers to a benchmark existing as at the in force date (30 June 2016) and not as at the application date (1 January 2018³) – could have important implications as to benchmarks launched in the interim period. Industry groups (notably ISDA) are lobbying for a change and/or clarity in this regard.

ESMA has also proposed a list of criteria which competent authorities should take into account when making a determination as to whether ceasing or changing the benchmark would trigger force majeure, frustration or breach, to ensure a consistent approach (see Force Majeure, Frustration, Breach below).

Third country benchmarks: absent any equivalence decision, recognition of the administrator or endorsement of the benchmark, third country benchmarks which are already used in the EU may continue to be used, but only in respect of financial contracts, financial instruments or investment funds which referenced them prior to 1 January 2020.

_{1. Regime for "critical" benchmarks will apply from 30 June 2016.}

_{2. No new reference to any non-compliant benchmark may be added to a financial instrument, financial product or investment fund after 1 January 2020.}

_{3. Other than "critical" benchmarks – see footnote 1.}