ESMA has published an updated version of its questions and answers on the Benchmark Regulation. The Q&As attempt to provide clarification on a few key issues:
-
When are financial instruments traded on a systematic internaliser in scope of BMR?
-
When are banks issuing certificates "users of benchmarks"?
-
When are the written plans robust?
-
How should users reflect written plans in the contractual relationship with clients?
We summarise each below.
When are financial instruments traded on a systematic internaliser ("SI") in scope of BMR?
One of the most important questions for the derivatives industry has been the scope of the Benchmark Regulation ("BMR"). ESMA's clarification arises as a result of debate around the reference in Article 3 (1)(16) BMR, which says that a "financial instrument" means any of the instruments listed in Section C of Annex 1 to the MiFID II Directive for which a request for admission to trading on a trading venue has been made or which is traded on a trading venue, or which is traded via a systematic internaliser (our emphasis added).
The ESMA Q&As have provided some clarification on this point. ESMA considers that “traded via a systematic internaliser” as referred to in Article 3(1)(16) BMR should be read to cover:
- all instruments described in reference data provided by a systematic internaliser in compliance with Article 27 of MiFIR (even if traded outside that systematic internaliser); and
- all other instruments that are actually traded on a systematic internaliser, regardless of any requirement of the systematic internaliser to provide reference data.
Many will note that this Q&A does not answer questions raised by some market participants as to whether a firm can be an SI in the first place, if the instrument is not a pre-existing "TOTV" instrument. Although there is a technical view to the contrary, the view adopted by many is that it cannot – meaning that the SI limb would be co-extensive with the "trading on a trading venue" limb of the financial instrument definition (read in this light, the ESMA Q&A confirms that the BMR applies to TOTV instruments, which are those currently reported under RTS 23 of MiFID II).
When are banks issuing certificates "users of benchmarks"?
ESMA notes that many banks issue certificates where the underlying is a portfolio composed of different components and that the value of the portfolio is regularly determined and may also be regularly published pursuant to the Prospectus Regulation. ESMA specifically uses the term "certificates", but presumably means any form of security.
ESMA further notes that the terms "index", "basket", "reference portfolio", "reference index", "benchmark" and variations of these terms are used by market participants in relation to these certificates in a manner that does not reflect the BMR terminology.
In relation to such certificates, ESMA confirms that there may be cases where the reference portfolio as described above fulfils the BMR definition of an "index", provided that the level of the portfolio is “published or made available to the public” (as required by point (a) in Article 3(1)(1)). Therefore, if the certificate is a financial instrument, the reference portfolio should be considered a "benchmark" and its provider should be considered an "administrator" under the BMR.
In such a case, ESMA further confirms that the bank’s activity of issuing certificates linked to such reference portfolio (which is selected by the same issuing bank), fulfils the BMR definition of "use of a benchmark" in Article 3(1)(7). ESMA also confirms that the fact that the benchmark is both provided and used by the same supervised entity does not preclude the fulfilment of the definition of “use of a benchmark”nthere is no requirement for the provider and the user of a benchmark to be distinct entities.
Most market participants have presumably been operating on the above understanding already; but if nothing else, ESMA's guidance on this point further highlights the breadth of the scope of the BMR.
When are the written plans robust?
Article 28(2) of the BMR requires users to produce and maintain robust written plans. Many in industry have queried the level of detail required and what the exact content should comprise. ESMA has now clarified that it considers that written plans are robust if they:
- determine operational procedures in writing;
- they include detailed courses of action, relevant communication channels and arrangements for different scenarios and contingencies; and
- are thorough and adequate.
ESMA notes that the written plans should reflect the nature and size of the individual benchmark and the scale of its use in the markets. ESMA further considers that maintaining the robust written plans requires supervised entities to continuously monitor relevant factors and update arrangements as appropriate.
How should users reflect written plans in the contractual relationship with clients?
The final new response from ESMA considers how supervised entities should reflect their written plans in contractual relationships with clients. ESMA confirms that firms should be able to demonstrate to their regulators that they have communicated their written plans to their clients and "that the written plans are legally effective under applicable Member States law" (this point may raise more questions, than it answers).
Interestingly, ESMA gives the example of prospectuses which may be contractual documents under national law. Here ESMA considers whether supervised entities may then opt to update outstanding prospectuses approved prior to 1 January 2018 in order to guarantee that all new investors in an investment fund are subject to such terms – which would now include provisions reflecting the written plans. ESMA notes that in other cases, supervised entities may opt to include a reference to their written plans in other contractual documents that they formalise with new investors.
Conclusion
The updated Q&As will bring the Benchmark Regulation back into the limelight. They are likely to motivate firms to revisit scoping exercises they have previously carried out, and consider the impact of the new Q&As on their 28(2) workstreams more generally.
Co-author: Sean McCaffrey, Associate
