FRENCH BANKING FEDERATION RESPONSE TO THE ESMA AND EBA CONSULTATION DOCUMENT REGARDING THE PRINCIPLES FOR BENCHMARKS-SETTING PROCESSES IN THE EU

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FRENCH BANKING FEDERATION RESPONSE TO THE ESMA AND EBA CONSULTATION DOCUMENT REGARDING THE PRINCIPLES FOR BENCHMARKS-SETTING PROCESSES IN THE EU The Fédération Bancaire Française (the French Banking

It comprises all of the credit establishments registered as banks and doing business in France, i.e. more than 450 commercial and cooperative banks.

1 FRENCH BANKING FEDERATION RESPONSE TO THE ESMA AND EBA CONSULTATION DOCUMENT REGARDING THE PRINCIPLES FOR BENCHMARKS-SETTING PROCESSES IN THE EU The Fédération Bancaire Française (the French Banking Federation, hereinafter FBF) is the professional organisation that represents the interests of the banking sector in France. It comprises all of the credit establishments registered as banks and doing business in France, i.e. more than 450 commercial and cooperative banks. FBF member banks have 40,000 permanent branches in France, 400,000 employees and 60 million customers. French banks welcome the initiatives undertaken by the European Securities and Markets Authority (ESMA) and the European banking Authority (EBA) and the opportunity to contribute to the analysis of the reforms needed to restore confidence in benchmarks, among which the EURIBOR is of particular importance. The FBF shares the view that upholding the integrity and credibility of these market benchmarks is important. The ESMA/EBA consultation paper is broad and determines the scope of applicability of Principles in light of the susceptibility of benchmark categories to conflict of interests or manipulation as well as their importance to financial markets activity, the real economy or investor protection. The FBF s response focuses when possible on the scope for EURIBOR reform, as the benchmark represents a key interest rate in the euro area. The FBF believes that ESMA and EBA s current assessment of the need for benchmark reform represents an opportunity to consider which measures can be taken to increase the EURIBOR s reliability, representativeness and resilience, which would in turn increase the market s confidence in the benchmark. KEY POINTS At EU level, the European Commission already put forward proposals to amend its proposals for a Regulation on market abuse (MAD) and for a Directive on criminal sanctions for market abuse to ensure that any manipulation of benchmarks is clearly and unequivocally illegal. The FBF believes that bringing benchmark and indices within the EU regime for market abuse is a step forward in order to re-establish confidence in the indices setting process. 1

2 ESMA and EBA are closely working with IOSCO and the European Commission to ensure that any principles arising from this consultation are closely aligned. The FBF believe that a consistent and coordinated response is desirable. The FBF supports the introduction of European public supervision on benchmarks. Supervision should also apply ex-ante and ex-post (before and after the fixing delivery). The FBF highlights that an eventual substitution of existent money-market indices by new ones or the introduction of changes regarding the calculation method would certainly have important legal and economic implications for financial institutions. Regarding EURIBOR, the FBF supports an evolution of the current benchmarks based on enhanced governance and public supervision rather than changes to the definition or calculation. Regarding transparency over changes to the methodology, administrators should set out how prospective changes will be subject to consultation.the FBF underlines that the process of reforming EURIBOR, and potentially, other interest rate benchmarks should be coordinated at a European and global level to ensure consistency and a level playing field. The FBF stresses that a too rigid regime or drastic changes could make it difficult to get an appropriate number of panel banks to contribute to the money-market indices setting process. The FBF believes that a Code of Conduct, in conjunction with a clear benchmark definition and detailed and transparent contributions guidelines, a robust control framework with pre- and post-submission controls, regular audits and public supervision, would provide sufficient oversight to mitigate the risks that have recently been identified in the markets. Procedures and processes should be sufficiently detailed at European level (begging the question or providing the guidelines is not enough) to allow uniform implementation at national level. Should this harmonization not occur, there could be a risk of diverging interpretation in addition to legal uncertainties issues. SUMMARY OF QUESTIONS Question 1: Definition of the activities of benchmark setting Do you agree with the definitions provided in this section? Is this list of activities complete and accurate? Concerns over the fragility of certain benchmarks in terms of both their integrity and the continuity of provision have the potential to undermine market confidence, which may affect the real economy and investors. The FBF want to stress that to ensure that markets are fair, efficient and transparent, benchmarks should have the following characteristics in order to be credible: 2

3 1. Representative: a benchmark should clearly convey the economic realities of the underlying interest it seeks to measure to its users; 2. Transparent: there should be sufficient transparency over the methodology, calculation and inputs to allow users to understand how the benchmark is derived and its potential limitations; 3. Reliable: the data relied upon to construct the benchmark should be sufficient to represent that interest and the data should be bona fide; 4. Subject to clear governance and accountability mechanisms. The benchmark-setting process must rely on a robust Code of Conduct, setting out a clear definition of the benchmark and transactions to be taken into account, clear contributions process guidelines including sufficient safeguards at contributors level and calculator agent s level and appropriate sanctions. Benchmarks used by banks concern prices, rates, indices or figures that are: Made available to users, whether free of charge or on payment; Calculated by the application of a formula or another method of calculation to, or an assessment of the value of, one or more underlying assets, prices or certain other data, including estimated prices, rates or other values, or surveys; Used for reference for determining interest payable, price at which a financial instrument may be bought or sold or traded or redeemed, or the value of a financial instrument; and/or measuring the performance of a financial instrument. The benchmark administration should include all stages and processes involved in the production and dissemination of a benchmark. The benchmark administrator represents the organization which controls the creation and operation of the benchmark administration process. In particular, the entity has responsibility for the calculation of the benchmark, applying the benchmark methodology and disseminating the benchmark. The calculation agent is a legal entity with delegated responsibility for determining a benchmark through the application of a formula or other method of calculating the information, in accordance with the methodology set out by the administrator (Thomson Reuters for EURIBOR) The benchmark publisher is the legal entity publishing the benchmark values. The methodology must include the written rules and procedures according to which information is collected and the benchmark is determined. 3

4 Question 2: Principles for benchmarks Would you consider a set of principles a useful framework for guiding benchmark setting activities until a possible formal regulatory and supervisory framework has been established in the EU? The FBF consider that the following categories of benchmarks referring major financial markets 1 or asset classes referenced by benchmarks drew out a number of common themes in respect of their methodology, transparency and governance arrangements. A set of principles, even if a large number of indices are constructed in many different ways is useful in order to instil confidence in financial markets, and guarantee the necessary accuracy and integrity of the formation process. Regarding new principles for benchmarks, the FBF insist on the necessity of a consistent and coordinated response at a European and global level to ensure that any principles arising from this consultation are closely aligned in a level playing field perspective. Question 3: General principles for benchmarks 1. Regarding Governance For the FBF, credible benchmarks should be supported by a governance framework that addresses conflicts of interest and incorporates an oversight committee or other independent body to oversee the production of the benchmark and all other relevant activities. With regard to the composition of submitting panels, the FBF believes that the panel must be as large and representative as possible in order to preserve the credibility and accuracy of the benchmark. With regards to the management of potential conflict of interests between the submitters and the administrator, French banks are in favor of the improvement of the composition of the EURIBOR Steering Committee that should be broadened to make it more independent and more diverse, including members who are not affiliated to panel banks. Other classes of stakeholders should further develop its independence and diversity. When possible, French banks are in favor of the creation of an independent body responsible for identifying and managing potential conflicts of interests. 1 Principles may concern: Interbank borrowing markets, which are referenced by rates such as LIBOR, EURIBOR, and are usually based on banks estimates of borrowing rates; Overnight Lending and Repo markets, which are represented by overnight rates (EONIA, Federal Funds Rate); Swap markets, referenced in rates such as the Overnight Index Swap (OIS); Equity markets, which cover listed equity securities; Credit markets, which cover sovereign bonds, corporate bonds and CDS; Commodities markets, which cover specific commodity spot or futures prices; Energy markets; Currency markets, which can be represented by specific or aggregate benchmarks; Alternative investments performance indices, such as hedge funds indices. 4

5 2. Supervision Confidence in financial markets is indeed crucial. In order to guarantee that confidence, a strong cooperation among European and national regulators authorities, as well as contributors, must be developed through rules for supervision and, above all, through a constructive and regular dialog. In this respect, a dedicated entity, gathering representatives of supervision authorities and contributors could make sense, With regard to the strengthening of sanctions, it seems that such provision already exist through the creation of criminal sanctions for market abuse regarding the manipulation of benchmarks (sanctions that have been integrated into the proposal for the new Directive on market abuse). It is therefore not necessary to take it one step further. Contributors also have need for market and regulators confidence (regarding them as market abusers by nature would be counterproductive). 3. Regarding Transparency of benchmark methodologies The FBF want to stress that is important that the key terminology in the benchmark is clearly defined as well as the benchmark s objective. The user should clearly understand what the benchmark is trying to represent, and how the inputs are obtained and the outputs derived. For instance, the term Prime Bank regarding the EURIBOR may not always be clearly defined 2. Transparency of methodology is especially important when assessments are based on a mix of both transactional inputs (i.e., completed transactions, bid and offers) and non-transaction market information (expert judgments). Regarding transparency over changes to the methodology, administrators should set out how prospective changes will be subject to consultation. The FBF highlights that an eventual substitution of existent money-market indices by new ones or the introduction of changes regarding the calculation method would certainly have important legal and economic implications for financial institutions. 4. Regarding Continuity of participation The FBF underline s the risk posed by voluntary submission of inputs, if submitters cease to participate in the benchmark altogether. With the recent events, contributing to an index may be considered as an additional burden, given the costs and resources that additional compliance and governance measures will generate, as well as a potential source of reputational risk. As identified in the Wheatley report, the representativeness, and in extremis, the viability and continuity of the benchmark itself could be threatened if a sufficient number of submitters are no longer willing to contribute to the benchmark setting process. For the FBF, a too rigid regime or drastic changes could make it difficult to get an appropriate number of panel banks to contribute, in particular to the money-market indices setting process. 2 Euribor-EBF has been working on clarifying the key terminology of the Euribor benchmark, by defining the prime bank and interbank transactions wording in the definition. 5

6 Question 4: Principles for firms involved in benchmark data submissions The FBF agrees with the principles for firms. Inputs may be subject to error, the administrator should seek to verify the accuracy and plausibility of the inputs. This could take the form of identifying and, if appropriate, seeking for clarification. Regarding determination and submission of the contribution There should be a clear definition of roles in the contribution process in order to prevent conflicts of interests. In addition, contributing staff must receive appropriate training. The contribution teams should be responsible for inputting the rates into the calculator agent s system, once it is validated by the Market Risk department. The Compliance department should be in charge of controlling the internal contribution processes and respect of the Code of Conduct. Regular internal and external audits must also be performed to secure confidence in the index and strengthening its credibility. Regarding conflicts of interest Conflicts of interest can arise at the level of the submitter, between submitters at different entities, and between submitters, administrators, calculation agents and other third parties due to economic incentives and the relationship between market participants. For the FBF, an effective conflicts of interest policy is necessary to manage such potential conflicts. Question 5: Principles for benchmark administrators Benchmark administrator s mission is key because it includes all stages and processes involved in the production and dissemination of a benchmark. The FBF agrees with the principles for benchmark administrators and underlines the necessity of robust methodologies with well-defined criteria for the calculation of the benchmark. Administrators should have written procedures for receiving, investigating and retaining records concerning user complaints, including benchmark determinations and operational concerns. The Administrators processes and governance structure should be subject to both internal and external audits, followed by public disclosure of the results. Internal and external audits should be performed once a year. Question 6: Principles for benchmark calculation agents The FBF agrees with the principles for benchmark calculation agents. At some point, the calculation agent should have its own Code of Conduct and perform internal and external 6

7 audits and keep complete, transparent and clear records of all submissions from each panel over the years. Question 7: Principles for benchmark publishers The FBF agrees with the principles for benchmark publishers: the last stage involves disseminating the benchmark to users, which can be done either by the administrator directly or through a benchmark publisher. The legal entity publishing the benchmark values must include available values to users, at least on the internet. Question 8: Principles for users of benchmarks Like described in question 1, a benchmark should clearly convey the economic realities of the underlying interest it seeks to measure to its users and must be transparent to allow users to understand how the benchmark is derived and its potential limitations. The FBF agrees with the principles for benchmark users, but regarding the case of transparency over changes to the methodology, stresses the fact that administrators should clearly disclose changes to the methodology. Some benchmarks, indices in particular, require periodic changes in composition to remain representative. The exact processes for changes in composition vary. In some cases, it can be difficult for the administrator to publish rebalancing in advance, as this might move the market, to the detriment of certain instruments and market players. However, where the rebalancing cannot be reasonably published in advance, at a minimum, users may benefit from understanding the methodology for rebalancing to assess the continued suitability and representativeness of each benchmark they use. Nonetheless, administrators should use their good faith efforts to make sure that their consultation process is comprehensive, transparent, fair and timely. Users of a benchmark should also monitor changes to the benchmark s methodology to assess if it remains a suitable reference for the relevant financial products. Question 9: Practical application of the principles Are there any areas of benchmarks for which the above principles would be inadequate? If so, please provide details on the relevant benchmarks and the reasons of inadequacy. The FBF globally agree with the practical application of the principles. Anyway, for each input type, vulnerabilities can occur: Indeed, many benchmarks rely on voluntary submissions by market participants. In some cases, submitting entities self-report to administrators and can choose whether to participate in the submission process and to what extent. For example, hedge fund indices rely on voluntary reporting by fund managers on investment strategy and performance. 7

8 Partial or selective reporting of data or gaps in availability of submissions may undermine the credibility of the benchmark as a representation of the underlying interest and the resilience of the benchmark to market stress. To mitigate these concerns, administrators should develop procedures and policies governing submission discipline and frequency for contributing entities. Question 10: Continuity of benchmarks Which principles/criteria would you consider necessary to be established for the continuity of benchmarks in case of a change to the framework? Continuity of participation (refer to question 3, item 3) If the submission of inputs is not compulsory, there is a potential risk posed by voluntary if submitters cease to participate in the benchmark. The viability and continuity of the benchmark itself could be threatened if a sufficient number of submitters are no longer willing to contribute to the benchmark setting process. While making the contribution to the benchmarks compulsory might be a solution in order to preserve their accuracy and representativeness, the FBF recommends that the regulators envisage the possibility of introducing incentive measures in order to encourage panel banks to continue participating in setting these benchmarks ; keeping in mind that a too rigid regime or drastic changes could make it difficult to get an appropriate number of panel banks to contribute to the money-market indices setting process. 8

Consultation Paper. Principles for Benchmarks-Setting Processes in the EU. 11 January 2013 ESMA/2013/12

Consultation Paper. Principles for Benchmarks-Setting Processes in the EU. 11 January 2013 ESMA/2013/12 Consultation Paper Principles for Benchmarks-Setting Processes in the EU 11 January 2013 ESMA/2013/12 Date: 11 January 2013 ESMA/2013/12 Responding to this paper ESMA and EBA invite comments on all matters