Extraterritorial application of the EU Benchmark Regulation

Background

The EU Benchmark Regulation (EU 2016/1011) is now in effect and imposes wide-ranging obligations on the administrators of benchmarks which are used in the EU, those entities which contribute data to them and certain users of those benchmarks in the EU. While the regime generally applies to the EU, it also has extra-territorial provisions that will impact administrators and contributors located outside the EU in certain circumstances. Affected entities outside the EU should already be taking action to prepare for the end of the transitional relief on 1 January 2020.

Definition of "Benchmark"

The key gateway definition in determining whether the Benchmark Regulation applies is "benchmark". "Benchmark" is defined broadly in the Benchmark Regulation and comprises either:

(i) any index by reference to which the amount payable under a financial instrument that is traded on trading venues or via systematic internalisers in the EU or mortgage or consumer credit contracts, or the value of such a financial instrument, is determined; or

(ii) an index that is used to measure the performance of an investment fund.

An index is also widely defined under the Benchmarks Regulation and means a figure that is published or made available (ESMA has clarified that this means that the figure has been made accessible either directly or indirectly, to a potentially indeterminate number of persons other than the index provider or a determined number of recipients connected to the index provider) and that is regularly determined by the application of a formula or calculation or assessment or on the basis of the value of underlying assets or prices. A single price or reference value is not a benchmark since there is no calculation, input data or discretion (though a basket of securities – eg shares – each publishing single prices or values could be an "index" – see our discussion below).

Given the broad definition of "index", the question of whether a financial metric is a "benchmark" will often turn on whether that metric is used in a financial instrument that is traded on trading venues or via systematic internalisers in the EU or referenced by EU funds.

Extra-territorial application of the Benchmark Regulation 

The Benchmark Regulation applies to the provision of benchmarks, the contribution of input data to a benchmark and the use of a benchmark within the EU. The European Securities and Markets Authority (ESMA) has stated that it is not an ambition of the Benchmark Regulation to protect users of benchmarks worldwide and therefore ESMA does not consider that the Benchmark Regulation applies to the provision of benchmarks that are used exclusively outside the EU or the contribution of input data with respect to a benchmark that is used exclusively outside the EU. While ESMA's guidance is helpful to entities located outside the EU, such an entity could still fall within the scope of the Benchmark Regulation if it acts as an administrator or a contributor of a benchmark unless the transitional provisions apply. We consider each of these circumstances below.

Application to non-EU administrators

An entity may be a benchmark administrator if it has control over the provision of a benchmark that are used in financial instruments traded on trading venues or via systematic internalisers in the EU, mortgage or consumer credit contracts, or to measure the performance of investment funds. Therefore a non-EU entity that is an "administrator" for these purposes could fall within the scope of the Benchmark Regulation if it provides an index that is used by supervised entities in the EU. For example, if the administrator of an index located outside the EU licenses a supervised entity in the EU to reference its index in securities listed on an EU trading venue or in OTC derivative contracts traded via a systematic internaliser it would become indirectly subject to the regime (unless the transitional provisions described below apply). This is because EU supervised entities are restricted in their use of benchmarks to those which are Benchmark Regulation compliant. Non-European benchmarks have limited routes to Benchmark Regulation compliance, which are set out below.

In addition, the broad definition of "index" could also result in entities located outside the EU inadvertently undertaking activities that are subject to the Benchmark Regulation. In particular, ESMA has confirmed that there may be cases where a financial instrument that references a basket of securities or a reference portfolio that is regularly determined and published fulfils the definition of "index" for the purposes of the regime and therefore the non-EU issuer or calculation agent would be acting as the benchmark administrator. If such financial instruments are listed on an EU trading venue or traded via a systematic internaliser then one of the three regimes described below would need to be followed (equivalence, recognition or endorsement).

Application to non-EU benchmark contributors

An entity may be a contributor under the Benchmark Regulation if it contributes input data that is not readily available to the administrator, and provides that input data for the purpose of a benchmark determination. There are two classes of contributor: "contributor" and "supervised contributor". A supervised contributor is essentially an authorised firm under certain European directives which contributes input data to an administrator in the EU and "contributor" is a natural or legal person who contributes input data to an administrator. A non-EU firm could therefore be regarded as a contributor although it is less likely to be caught as a supervised contributor.

Firms located outside the EU that contribute to benchmarks provided by an entity located in the EU will be expected to comply with the code of conduct (which is only required for certain types of benchmarks) for contributors developed by the administrator. Recital 30 of the BMR states: "The administrator should be satisfied that contributors adhere to the code of conduct. Where contributors are located in third countries, the administrator should be satisfied to the extent possible".

Transitional provisions

With respect to the transitional provisions, the Benchmark Regulation (as clarified by ESMA guidance) permits benchmarks provided by entities located outside the EU to continue to be used in existing financial instruments post 1 January 2020 until maturity by EU supervised entities where the benchmark is already used in the EU as a reference for financial instruments, financial contracts or for measuring the performance of investment funds on or before 1 January 2020. However, for new contracts to reference existing benchmarks after 1 January 2020 or for new benchmarks provided for the first time by a non-EU administrator after 1 January 2020, one of the three regimes described below will need to be followed (equivalence, recognition or endorsement).

Routes to compliance for non-EU administrators

There are three ways in which a benchmark provided by a non-EU administrator may qualify for use in the EU. We consider each of these options below.

Equivalence

This regime applies for non-EU countries in respect of which the European Commission has reached a decision that administrators are subject to equivalent binding requirements and effective supervision and a cooperation agreement is in place. Benchmark administrators that are authorised or registered and subject to supervision in such a country can notify ESMA to be included in the ESMA register, following which the benchmark in question may be used by supervised entities in the EU. From previous experience, equivalence decisions from Europe tend to be severely delayed and largely ad hoc in terms of the jurisdictions which are granted equivalence status. For this reason, this route is unlikely to provide sufficient comfort to non-EU benchmark administrators and certainly won't be available in the short term.

Recognition

Recognition requires an administrator located in a non-EU country to have legal representation in the EU through which the regulatory oversight is affected by an EU competent authority (to complicate matters, the European Commission has proposed legislation that will shift the approval process for recognition and endorsement to ESMA). The EU legal representative will be required to carry out oversight responsibilities and will effectively be accountable for the provision of the third country benchmarks within the EU. This requires the administrator to be able to comply with many of the requirements of the Benchmarks Regulation although this will be deemed to be satisfied if an independent auditor assesses that the administrator is compliant with the IOSCO principles for financial benchmarks or certification is provided by the local regulator. A cooperation agreement must also be in place between the relevant EU member state and the country in which the administrator is located. Recognition is intended as a temporary measure until such time as an equivalence decision is adopted by the European Commission.

Endorsement

EU administrators are able to endorse non-EU benchmarks where the EU administrator has a clear and well-defined role in the accountability framework of the third country administrator, can monitor the provision of the benchmark or family of benchmarks and there is an objective reason to provide the benchmark or family of benchmarks in a third country and endorse it for use in the EU. The EU endorsing administrator must remain fully responsible for the third country benchmark or family of benchmarks and its compliance with the Benchmark Regulation. Finally, the endorsing administrator must be able to demonstrate that the provision of the benchmark fulfils (on a mandatory or voluntary basis) requirements which are at least as stringent as the requirements of the Benchmark Regulation. This is most likely to apply to global entities where non-EU group companies provide benchmarks which can be easily endorsed by their European affiliates who have the relevant authorisation. Endorsement for non-EU benchmarks via third party EU administrators without any corporate connection will require a degree of cooperation and connectedness that may make this route difficult in practice.

Brexit

The impending exit of the United Kingdom from the EU creates additional uncertainty around the application of the three routes to compliance for non-EU entities. In the case of a no-deal Brexit (a "hard Brexit"), the EU would consider the UK as a third country and therefore UK entities could no longer act as an EU legal representative under the recognition route or as an endorsing entity under the endorsement route, nor could a non-EU entity use the UK Financial Conduct Authority (FCA) to apply for recognition, nor could an endorser apply to the FCA for endorsement.

If a deal is agreed, and this includes the proposed transition period to December 2020, then any FCA approved non-EU administrators would likely become approved in the EU without further action required. This would, however, be subject to the details of a deal.

Conclusion

As the expiration of the transitional regime approaches, non-EU administrators should be considering whether the Benchmark Regulation will affect their business and, if so, the costs and benefits of each of the options of equivalence, recognition and endorsement. Non-EU administrators and contributors may also wish to consider imposing contractual obligations on users of the relevant index not to bring the index within scope of the Benchmark Regulation by, for example, listing the relevant financial product on an EU trading venue.

Further information

All Ashurst briefings on the Benchmark Regulation and the legislation itself can be accessed on our Finance Hub