Stand out for the right reasons Financial Services Risk and Regulation. Hot topic. Increased clarity on BMR

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1 23 October 2017 Stand out for the right reasons Financial Services Risk and Regulation Hot topic Increased clarity on BMR Highlights As we approach the golive date, there s still much to do, especially for users. With the exception of targeted instructions for third country administrators, firms subject to BMR have sufficiently detailed requirements to finalise their implementation programs. On 29 September 2017, ESMA, the European Commission (EC) and the FCA published key documents clarifying the application of the European Benchmarks Regulation (BMR). These included: ESMA updated its BMR Q&As and consulted on draft guidelines for non-significant benchmarks. The EC adopted delegated acts on 29 September and 3 October The FCA launched its early opening period for administrators to submit draft applications for authorisation as of 1 October This hot topic explores the current status of the legislation and UK implementation, and provides a few observations on preparations by administrators, contributors and users. Where are we now? With less than 90 days before BMR goes live on 1 January 2018, many aspects of the rules have been confirmed: Level 1 measures BMR was published on 29 June 2016 and went into effect the following day. From 1 January 2018 supervised users can only use a benchmark if its EU administrator (or third country benchmark) appears on the ESMA register. As the FCA will not accept final applications until 1 January 2018, there will be few benchmarks on the ESMA register until Q But ESMA clarified in its first Q&As that administrators which provided benchmarks on or before 30 June 2016 can continue to do so without authorisation until 1 January This covers the overwhelming majority of administrators subject to BMR. Administrators that only started providing benchmarks after 30 June 2016 do not have to be authorised in January 2018 to continue providing these benchmarks but then cannot issue any new benchmarks until they are authorised.

2 Level 2 measures ESMA submitted draft technical standards (TS) to the EC in March The TS contain the detailed provisions on oversight function, input data, methodology, etc. primarily applicable to critical and significant benchmarks. They are still pending with the EC. The EC is expected to submit the TS to the European Parliament and the Council for scrutiny with the results of the consultation on provisions for non-significant benchmarks discussed below. ESMA submitted technical advice to the EC in November The EC consulted on the draft delegated acts in June 2017 and adopted them in September and October UK implementation The FCA consulted on the UK implementation of BMR in June It proposed to copy out BMR into the FCA Handbook while continuing to apply MAR8 to the eight specified benchmarks until all of them are authorised by 1 January 2020, where appropriate. The FCA also proposed to continue to apply the financial resources requirement to critical benchmarks even after MAR8 is fully supplanted by BMR. It plans to publish final handbook changes in October The FCA start accepting draft applications for authorisation from administrators as of 1 October ESMA Q&As on BMR ESMA updated the BMR Q&As, providing further clarity and inpretation for the industry. In this latest edition, ESMA clarifies the scope and definitions in BMR. Scope: Central bank administrators Although central banks are exempt from BMR, users of and contributors to benchmarks such as SONIA are not. Supervised users must still develop written plans to address a benchmark materially changing or ceasing. Likewise, supervised contributors must establish a governance and control framework. Scope: Single reference prices While BMR exempts a single reference price provided for a single instrument, ESMA states that calculations based on complex methodologies, input data and discretion are indicators that a single reference value is a benchmark. Equity baskets and indices based on the price of more than one instrument are benchmarks, while simple calculations, averages or setting and reviewing of weights in a combination of benchmarks are out of scope because they do not require discretion. Definition: Benchmark family An administrator may group benchmarks based on similar methodologies into one family with a single code of conduct. Administrators may group all their critical, significant and non-significant benchmarks into one single family. Families can also be grouped by input data: same nature (e.g. transaction-based or expert judgment) sector benchmarks (i.e. interest rate, commodity, regulated data) similar market (e.g. same underlying asset, shares of same sector or region), or similar economic reality (e.g. household income, GDP or rent). Definition: Use of a benchmark ESMA clarified who are the users of a benchmark when it is used to determine the amount payable under a financial instrument or a financial contract. Supervised users in this example include trading venues or systematic internalisers that trade or CCPs that clear a derivative which contains a benchmark which they chose. Otherwise, all parties to the derivatives transaction are considered users of the benchmark. ESMA CP on non-significant benchmarks In March 2017, ESMA issued TS which applied to critical and significant benchmarks only (see FSRR Hot Topic: BMR Nearly Final). It recently consulted on draft guidelines for non-significant benchmarks, covering the oversight function, input data, methodology and supervised contributors. In keeping with the proportionality principle, these guidelines provide administrators of and supervised contributors to non-significant benchmarks a measure of discretion compared to critical and significant benchmarks. Where BMR, TS or delegated acts permit administrators of non-significant benchmarks not to apply a specific provision, then the related guideline will not apply either. NCAs and market participants must make every effort to comply with ESMA guidelines. NCAs must also notify ESMA of whether they intend to comply or explain their reasons for non-compliance. NCAs comply by incorporating the guidelines into their supervisory practices. Administrators and contributors are not required to report compliance to ESMA, but are accountable to the NCA. Comments are due by 30 November ESMA will publish the final guidelines once the EC publishes the TS applicable to critical and significant benchmarks. Procedures, characteristics and positioning of oversight function (BMR Art. 5) Administrators of both critical and significant, and non-significant benchmarks must establish a 1 Hot Topic Financial Services Risk and Regulation

3 permanent and effective oversight function. But nonsignificant benchmarks do not have to provide a copy of arrangements to their NCAs or to establish a separate committee. Members of the oversight function with conflicts (e.g. users, contributors or external stakeholders) should not exceed a simple majority and at least one of the members should have appropriate skills and expertise, and sufficient knowledge of the market which the benchmark measures to oversee the provision of the benchmark. As with the TS, although members of the board may not permanently sit on the oversight committee, they may attend meetings in a non-voting capacity. The list of procedures governing the oversight committee of non-significant benchmarks is slightly shorter than for critical and significant benchmarks. The oversight function need not establish terms of reference or criteria for observers attending meetings, nor publicly disclose oversight committee members. ESMA proposes a non-exhaustive list of governance arrangements for the oversight function, including but not limited to: one or more natural persons employed by or under the control of the administrator not directly involved in the provision of the benchmark an independent committee with a balance of supervised users, contributors or external stakeholders (e.g. FMIs) and independent staff or members not directly involved in the administration of the benchmark multiple committees responsible for or performing oversight tasks where a single person/committee is responsible for its overall direction and for interaction with the management body and NCA. Appropriateness and verifiability of input data (BMR Art. 11) All administrators must have robust controls to ensure the reliability of input data. But administrators of non-significant benchmarks are subject to a less stringent standard. These administrators must confirm the submitter s authorisation, source of data and that the input data align with the methodology. Administrators should establish oversight and verification processes for contribution from the front office. ESMA imposes checks for administrators of non-significant benchmarks and a control structure across the three lines of defence for contributors. The first line of defence reviews data integrity and accuracy before contribution, while the second line reviews the same after contribution. Internal audit performs an independent review of both. Transparency of methodology (BMR Art. 13) Again all administrators must ensure that their benchmarks are reliable and accurate. They must also ensure that benchmark users have sufficient information about the methodology to determine that the benchmark is appropriate for the intended use. ESMA reduces the list of items administrators of nonsignificant benchmarks should publish or make available. In addition to details about the methodology itself, they should also publish details of the internal review of the methodology as well as any proposed material changes to it. Governance and control requirements for supervised contributors (BMR Art. 16) Although administrators should impose a code of conduct on contributors, supervised contributors are subject to additional governance and control requirements. Contributors to non-significant benchmarks can opt out of the application of the systems and controls for the integrity and reliability of input data and the use of judgment and discretion. ESMA proposes a control framework for supervised contributors with effective oversight, whistleblowing policy and procedures for detecting violations for BMR. This also includes a process for designating submitters, as well as procedures for retaining and monitoring both contributions and related communications with submitters. To manage conflicts, contributors to non-significant benchmarks should establish a register of conflicts, detach remuneration from the benchmark or performance of the contributor, and where appropriate physically separate submitters from other employees. EC delegated acts The EC also published four delegated regulations: 1. Making available to the public and administering arrangements for determining a benchmark. 2. Impact of critical benchmarks on Member States. 3. Valuing benchmarks. 4. Cessation or material change. There are no major changes from the draft versions on which the EC consulted in June 2017 (see FSRR Hot Topic: FCA and European Commission issue key texts on BMR implementation). The Council and European Parliament now have three months to object or accept the delegated acts. It is worth emphasising that although ESMA issued technical advice on endorsements in November 2016, the EC has yet to issue the corresponding delegated act even in draft. There seems to be a reluctance on the part of the EU to issue measures which directly 2 Hot Topic Financial Services Risk and Regulation

4 impact third country firms, perhaps reflecting political sensitivities related to the Brexit negotiations. FCA early opening period The FCA started accepting draft applications for authorisation on 1 October The UK regulator suggests that EU administrators make their draft applications as complete as possible with minimal updates required once it starts accepting formal applications as of 1 January Unfortunately, third country administrators seeking recognition or endorsement must await final applications which will not be available until the new year. Next steps and market response Over the last 18 months, we have seen our clients grow in their understanding and readiness for BMR. Market participants and regulators have primarily focused on the impact on sell-side firms, in particular definition and scope to determine whether and when an administrator required authorisation. Increasingly though, the market is awakening to the considerable impact of BMR buy-side firms, which are primarily, though not exclusively, users of benchmarks. Administrators Administrators have developed inventories of the benchmarks they provide and determined when they are required to apply. Some have begun to restructure their firms to isolate the administration business. As noted above, the FCA will not start reviewing final applications until 1 January The ESMA register will not list many, if any, authorised EU administors or third country benchmarks before Q Administrators can help in the interim by publishing a statement on their websites, notifying market participants whether they are seeking authorisation in 2018 or Contributors Contributors are awaiting clarity on their obligations under the codes of conduct from administrators. Supervised contributors are building control frameworks, which impose obligations independent of the codes of conduct from administrators. Users Though still somewhat behind the curve, supervised users are belatedly beginning to drill down into their obligations. Asset and wealth management firms are starting to establish fall-back policies and are scrutinising where they meet the definition of use of a benchmark. In several cases, during the scoping process users are determining that they may in fact be administrators as well. For example, buy-side firms are analysing the implications of BMR for blended reference rates where a user determines the amount payable on financial contract by combining a benchmark with another calculation. The day after it started accepting draft applications from administrators, the FCA notified benchmark users that they need not apply for authorisation under BMR unless they are also administrators. The UK regulator admonished them to understand their obligations under the regulation. This is a clear indication that users still have work to do. As we approach the go-live date, there s still much to do, especially for users. With the exception of targeted instructions for third country administrators, firms subject to BMR have sufficiently detailed requirements to finalise their implementation programs. Any new elaboration will likely come in the form of level 3 guidance (e.g. ESMA Q&As and guidelines) which is continually updated as events warrant. Non-EU administrators should make a business decision on whether to apply for authorisation by recognition or endorsement in Admittedly, the EC, ESMA and the FCA have provided administrators of third country benchmarks with little direction. Unless a third country administrator is authorised, supervised users may not be able to use their benchmarks or default to benchmarks whose administrators are definitely authorised, whether they are subject to the transitional provisions or not. Final applications are available as of 1 January In the case of recognition, the third country administrator requires an external audit to show compliance with IOSCO and BMR. 3 Hot Topic Financial Services Risk and Regulation

5 Contacts Mike J. Wallace Partner E: T: +44 (0) Greg Campbell Senior Manager E: T: +44 (0) Cheryl McGee Wallace Manager E: T: +44 (0) This publication has been prepared for general guidance on matters of interest only, and does not cons itute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it PricewaterhouseCoopers LLP. All rights reserved. In this document, PwC refers to the UK member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details JD-OS

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