The FCA's CP on the Benchmark Regulation: a story of moving parts

On 22 June 2017, the FCA published a consultation paper (CP) on proposed amendments to its Handbook to reflect the application of the European Benchmark Regulation (BMR). Never before have we seen the regulator grapple with so many moving parts during the transposition of European rules. Not only are there still some parts of the BMR that require clarification from the European bodies (in particular, in respect of the transitional provisions), HM Treasury has not yet published the draft text required to change the primary legislation in the UK to incorporate the BMR provisions and give the FCA the power to regulate affected firms. Add to this the fact that the FCA wants to avoid any 'regulatory gap' arising between the existing benchmark regime and the transitional provisions under the BMR, and its anticipation of future changes that may be needed as a result of the extension of the senior managers regime, and the CP makes for tricky reading.

The BMR will have direct effect in the UK anyway – before Brexit, at least – so the FCA is mainly deciding which elements of its regulatory regime should apply to administrators and contributors and which should not. It's mostly good news for the industry – a lot of rules will be switched off for benchmarks - but the FCA is focussing on key issues like management responsibility and reporting suspected manipulation. People will read this carefully, particularly in relation to the FCA's stance on the transitional provisions, which is in line with current European guidance but which is not helpful for administrators (or, for that matter, users) of benchmarks. However, there is still hope that the European Commission and ESMA will clarify the position in a more favourable way, through additional guidance which is expected to be published shortly. Our summary below highlights key points from the UK regulator's attempt to make sense of it all and looks at some of the practical arrangements the FCA has put in place to limit the impact on business continuity, particularly for administrators.

Background

The BMR aims to ensure the accuracy, robustness and integrity of benchmarks and the way in which benchmarks are determined. This is achieved by setting out rules governing benchmark administrators, contributors and users, which vary depending on the nature of the benchmark in question.

Our previous briefings track the journey of the BMR through the European legislative process. The most recent briefing can be found here.

The UK is one of the few European countries in which benchmark administration and contribution is already regulated in relation to eight listed benchmarks, known as 'specified benchmarks'. This means that provisions already exist in the FCA Handbook governing the five administrators that provide those specified benchmarks and their benchmark activities. These provisions are subject to most of the proposed changes in the CP to align the UK regime with the BMR. However, the BMR widens the definition of a benchmark and the FCA expects HM Treasury's legislation to refer to 'regulated benchmarks', which will have the meaning given in the BMR. 

As a regulation, the BMR is directly applicable in member states and so, as with its approach to the application of the Market Abuse Regulation, the FCA is proposing to delete many of the existing Handbook provisions in relation to specified benchmarks and replace them with signposts to the relevant provisions in the BMR.

Who is the CP directed at?

The FCA makes it clear that most of the proposed changes to the Handbook affect administrators and contributors. For benchmark users, the BMR should be their primary source rather than the Handbook provisions, meaning that there is little in the CP directly affecting these entities, which may come as good news. In reality, though, some of the issues raised in the CP are of key importance to users - in particular, the transitional regime.

Transitional provisions and the FCA's interpretation of 'existing benchmark'

Generally, the BMR applies from 1 January 2018. From this date, benchmark administrators can apply for authorisation or registration during a two year transitional period by the end of which benchmark administrators must be authorised or registered. During that transitional period, users can continue to use 'existing benchmarks' - a term which is not defined in the BMR and which, as we have highlighted in our previous briefings, is the subject of much debate. The FCA makes it clear that, in line with European guidance - and subject to any further guidance on this - it is working on the assumption that 'existing benchmark' means a benchmark in use before 1 January 2018. The FCA says that 'benchmarks in use before 1 January 2018 can continue to be used during the transitional period, but that from that date (i.e. 1 January 2018) any new benchmarks can be used only if the administrator is authorised or registered'.

This is not quite what industry had been hoping for (though it is no surprise). Even ESMA acknowledged in its final report on draft technical standards under the BMR, published in March, that this interpretation will lead to market disruption, particularly for administrators who frequently produce new benchmarks. This assumption by the UK regulator raises a number of issues:

• The phrase 'in use' suggests that benchmarks would have to be used by users in financial instruments or contracts before 1 January 2018 in order for them to be used post 1 January 2018, and not just warehoused ready for use by an administrator or pending the launch of a financial product after that date; and
•  Administrators will not be able to produce any benchmarks for use in financial instruments or contracts post 1 January 2018 until they are authorised or registered. From a user's perspective, this means that issuers or manufacturers of financial products that reference benchmarks in their products have a limited choice of either (i) benchmarks existing before 1 January 2018, or (ii) benchmarks produced by administrators which have been authorised or registered, which will take some time given the lag in processing applications that the FCA admits in the CP will naturally occur.

In reality, the FCA has little option but to repeat this reading of BMR, though it is disappointing. Industry will hope that the European Commission heeds ESMA's request for urgent guidance on this to provide a more workable solution.

In light of the transitional regime, the FCA is keen to avoid a 'regulatory gap' between the existing regime and the authorisation of those administrators who are currently caught because they administer a specified benchmark under existing provisions. Therefore, the FCA is proposing keeping some of the Handbook requirements for specified benchmark administrators until the five relevant administrators are authorised or registered. This will make the Handbook provisions on benchmarks slightly confusing until all five administrators are authorised or registered, at which point the FCA will remove the relevant provisions via proposals set out in a Quarterly Consultation.

Notifications to the regulator

The BMR requires administrators to report to their competent authority any conduct that may involve manipulation or attempted manipulation of a benchmark under the Market Abuse Regulation. The FCA is proposing guidance that requires administrators to notify them without delay of any notification that the administrator receives from a contributor about manipulation or attempted manipulation. The FCA is also considering a rule to require any supervised benchmark contributor to notify it directly of any suspicion of manipulation or attempted manipulation (exceeding the requirements of the BMR) and has said that it will 'make a decision on whether to make a rule of this type in light of this consultation'.

Capital requirements of administrators

There is some good news for administrators on the prudential side. Currently, the FCA applies prudential requirements to the five administrators of specified benchmarks. There are no prudential requirements in the BMR. The FCA however proposes maintaining its existing prudential requirements, but only in relation to administrators of 'critical benchmarks'. At present, of the existing specified benchmarks, only LIBOR is expected to be a critical benchmark. This means that, for administrators currently caught in the UK regime whose benchmarks are not critical, these prudential requirements will no longer apply. And for most other administrators (of significant and non-significant benchmarks) brought into scope under the BMR, there are no prudential requirements.

Applications to the regulator - timing

Benchmark administrators can apply for either authorisation or registration. The choice will depend on the type of benchmarks they administer and whether the administrator is a supervised entity (being a MiFID firm, CRD firm or Solvency II firm, amongst others).

It will only be possible for firms to make formal applications to the FCA under the BMR from 1 January 2018, but the FCA intends to allow firms to submit draft applications from 1 October 2017 to help the regulator and firms to make a start with the process. Firms will be able to provide feedback on the proposed application format from 6 July 2017. The application fee, described below, is only payable from 1 January 2018 but the FCA hopes that by frontrunning some of the authorisation work in advance of the deadline, firms that are worried about being able to provide new benchmarks continuously will not be impacted as much as they otherwise would.

The FCA will have 45 days to process applications for registration compared to four months for applications for authorisation. These timeframes will start when an application is officially made, not from the date of submission of any draft.

How much will it cost?

Regulated firms take a keen interest in the annual FCA fee consultation. For some benchmark administrators, the BMR will bring them within the FCA's perimeter for the first time. As a result, the cost of being regulated will be important. The FCA has set out clearly its charging structure for benchmark administrators. The regulator does not intend to distinguish between authorised and registered benchmark administrators in its fee structure because, once a firm is through the registration or authorisation 'gateway', the requirements with which they need to comply will not be affected by their status (i.e. registered or authorised). Nor does the fee structure take into account how many benchmarks an administrator administers. There will be two types of fees levied:

• a one-off fee on application:

• £25,000 for 'complex' applications i.e. administrators of critical benchmarks;
• £5,000 for 'moderately complex' applications i.e. administrators of significant benchmarks, commodity benchmarks, interest rate benchmarks and recognition of third country benchmarks;
• £1,500 for straightforward applications i.e. administrators of non-significant benchmarks and endorsement of third country benchmarks; and

• annual periodic fees.

It is important to note that the one-off application fee applies irrespective of the number of benchmarks administered and, if new benchmarks are added (administered), a notification rather than a new application is required - so no further application fees apply. For firms which are already regulated for other activities and which apply for permission to administer benchmarks, the full fee is payable. The benchmark administration fee structure is standalone and will not be amalgamated into the fee structure if other permissions are held or being applied for. This is different to the usual method. Applications for endorsements of third country benchmarks will also incur the full one-off fee.

The ongoing periodic fees have not yet been set, but the FCA has given a range for firms to use for business planning purposes. This is dependent on the income generated by the benchmark provision. There is a minimum fee threshold which will be set at an income of £100,000 and which is likely to be around £1,095 based on current figures. Above this threshold firms would pay the minimum fee plus a variable fee, which is currently estimated at £10-£20 per £1,000 of income.

One of the issues with these proposals is that the BMR has such a wide definition of 'benchmark' that the population of administrators will be greatly increased from 1 January 2018, and not all benchmark administrators who are caught will necessarily administer benchmarks on a paid basis. The fee proposals also require firms who administer benchmarks to identify income generated from this business line separate to other services provided. This might be new for administrators who were not previously regulated, and will not necessarily be straightforward for regulated firms either. Actual rates for the periodic fees will be consulted on in March or April 2018.

Overlap with FCA rules on governance

The FCA is mindful that there are, for the moment, two governance regimes in place: the senior managers and certification regime (SMCR) for banks, investment firms and insurers; and the approved persons regime for all other firms. Given that benchmark administrators and contributors may be firms subject to either of these regimes, the FCA has published proposals for amendments to the Handbook provisions for both. The Certification Regime under the SMCR will not apply to any roles relating to benchmark administration as, in the FCA's view, the BMR provisions are sufficient. For benchmark administrators who carry out no other regulated activities, only the provisions relating to directors are likely to apply. On the other hand, the FCA is proposing that the Code of Conduct for Staff (contained in COCON) should apply to all staff other than ancillary staff in firms subject to the BMR.

Contributors will need to notify the FCA of the senior personnel responsible for its benchmark contributions.

The FCA also acknowledges that the extension of the SMCR will apply to benchmark administrators and require further Handbook changes, on which they will consult later.

HM Treasury's legislation

The FCA briefly refers to the Treasury's expected statutory instrument, which will give effect to the legal changes needed under the BMR. Interestingly, the FCA states that it expects the Treasury's instrument to disapply the threshold conditions for authorisation, the rules of change of control and the appointed representative regime as far as benchmark administrators are concerned.

The FCA makes it clear that its proposals in the CP are based on the assumption that the European Commission will follow ESMA's advice to date and that HM Treasury will publish its legislative proposals in a form substantially similar to the draft which the FCA has seen. The FCA has pointed out that, if either of these assumptions are wrong, it may have to change the approach that it has set out in this CP.

Next steps

The consultation is open until 22 August 2017 with the exception of the draft application forms, which will be published on 6 July 2017 and remain open for comment for one month. The FCA intends to publish a policy statement in October 2017.

There will be further consultation on the consequential changes to the FCA's DEPP and EG resulting from the BMR later this year.

Draft delegated acts covering some of the more technical elements of the BMR, including the application of qualitative criteria for critical benchmarks and the meaning of 'made available to the public', were published on 23 June 2017. We are preparing a client briefing on this for publication shortly.

This remains, for the moment, a bit of a moveable feast.