Benchmark Regulation Briefing: ESMA updates level 3 Q&A guidance; Commission adopts delegated acts

What has happened?

On 29 September 2017, ESMA updated its level 3 Q&A guidance on the EU Benchmark Regulation (BMR). Our briefing on the first version of the Q&A, which provided guidance on two of the key transitional provisions under the BMR, is available here.

The new Q&A do not cover some of the key interpretation issues under the BMR (for example, there is no clarification on the interpretation of Article 28(2)), but ESMA intends to continue to review the Q&A and add or update questions and answers as necessary. We anticipate that further guidance will be published before the end of the year.

Separately, in the last week the European Commission has adopted delegated acts relating to:

• certain definitions contained in the BMR (including "made available to the public);
• the application of qualitative criteria for critical benchmarks; 
• the methods for determining the reference value of benchmarks; and
• conditions to assess the impact of the cessation of, or charges to, a benchmark.

The adopted texts differ very little from the original drafts, on which we commented here. The delegated acts are now subject to review by the European Parliament and the Council and, once agreed, will be published in the Official Journal of the EU.

Use of a benchmark

The meaning of "use of a benchmark" under the BMR is divided into five limbs. Limb (b) is intended to cover "use" in a derivatives context and has been the subject of much market discussion as it is unclear from the level 1 text exactly how this limb is to be interpreted. The text reads as follows:

"use of a benchmark" means [...] (b) determination of the amount payable under a financial instrument or a financial contract by referencing an index or a combination of indices; [...].

The confusion centres on the interpretation of "determination of the amount payable". Market participants have hitherto worked on the understanding that this phrase refers solely to calculation by the calculation agent of the amount payable under the contract in question, and is not intended to refer to both contracting parties.

However, it seems from the Q&A that this is not the intended interpretation. The relevant answer clarifies that the entity which would be considered to be "determining the amount payable" (and therefore "using" the benchmark) would be:

(a) where the contract is traded on a trading venue or is the subject of a request for admission to trading, and to the extent that the trading venue has set the relevant terms of the contract and therefore chosen the benchmark, the trading venue;

(b) where the contract is traded via a systematic internaliser (SI), and to the extent that the SI has set the relevant terms of the contract and therefore chosen the benchmark, the SI;

(c) where the contract is cleared by a CCP, and to the extent that the CCP has set the relevant terms of the contract and therefore chosen the benchmark, the CCP; and

(d) where none of the above applies, and particularly where the contract is traded on an organised trading facility that has not set the terms of the contract, each party to a transaction of a derivative.

Central bank exemption

The BMR contains an explicit provision exempting central banks from its scope. However, it was previously unclear whether this referred to all central banks, or only to EU central banks. This was a source of concern for EU users and potential users of benchmarks provided by non-EU central banks and has now been clarified in the Q&A.

The Q&A state that the term "central bank" refers to both EU and non-EU central banks, meaning that both EU central banks and third-country central banks are exempt from the provisions of the BMR. Accordingly, although benchmarks provided by third-country central banks will not be included in the ESMA register, EU supervised entities will still be able to use them.

However, EU users should be aware that the requirements of Article 28(2) of the BMR - the requirement to produce and maintain robust written plans setting out the actions that the user would take in the event of a material change to or discontinuance of such benchmark - will still apply. Governance and control requirements will also still apply to contributors to any such benchmark.

Single reference price exemption

The BMR also excludes from its scope "the provision of a single reference price for any financial instrument...". In the Q&A, ESMA notes that, with its singular use of the term "any financial instrument", this exclusion would not cover (for example) a basket of securities or an index based on the price of more than one financial instrument.

However, by way of background, ESMA refers to Recital 18 of the BMR, which provides that a single price or value used as a reference price in a financial instrument (for example, where the price of a single security is the reference price for an option or a future) should not be within scope of the BMR since there is no calculation, input data or discretion involved in referencing such single price or value. ESMA goes on to refer to Recital 13 of the BMR, saying that the setting and weighting of individual indices within a combination of indices for the purposes of determining the payout or value of a financial instrument or contract should not amount to provision of a benchmark, as such activity does not involve discretion.

ESMA further references Article 4(1)(a) of the EU Markets in FInancial Instruments Regulation (MiFIR), which refers to a price of a financial instrument published by one trading venue and referred to by another as a "reference price". Such "reference prices" may include a simple calculation (the example is given by ESMA of a re-calculation as a "per unit" price, or an averaging), but do not apply a complex methodology and do not involve the processing of additional data.

ESMA states that the term "single reference price" in the BMR should be interpreted in a similar way to the above "reference price" analysis in MiFIR (and presumably Recital 13 of the BMR). Therefore, it appears that ESMA considers that they key factors in determining whether a value derived from multiple underlying assets and referenced in a financial instrument or financial contract constitutes a benchmark are:

(i) whether the reference value calculation is simple (for example, it is calculated via averaging) or complex;

(ii) whether or not any additional data is involved in the calculation; and

(iii) whether or not the calculation involves any discretionary elements.

While this clarification will generally be welcomed by market participants, it may be difficult to determine whether the exemption is available in relation to specific financial instruments, particularly where the terms of that financial instrument require the calculation agent to perform multiple calculations in order to determine amounts payable under the financial instrument.

Grouping benchmarks into a "family"

The BMR allows administrators to group benchmarks into "families" for the purpose of publishing benchmark statements. A "family of benchmarks" is "a group of benchmarks provided by the same administrator and determined from input data of the same nature which provides specific measures of the same or similar market or economic reality".

In the Q&A, ESMA gives examples of what it considers to be "input data of the same nature": input data of an identical type, such as reported transactions, quoted pricesor expert judgement. So an administrator would not be able to group two benchmarks together if one were based on quote prices and one on, say, expert judgement.

ESMA also gives examples of where input data could be considered to provide "specific measures of the same or similar market or economic reality".

Finally, in this section, ESMA confirms that benchmarks of all categories (i.e. critical, significant and non-significant) can be grouped together into one family.