UniCredit reply to IOSCO on Principle for Financial Benchmarks

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1 For publication 14 May 2013 UniCredit reply to IOSCO on Principle for Financial Benchmarks UniCredit is a major international financial institution with strong roots in 22 European countries, active in approximately 50 markets, with about branches and more than employees. UniCredit is among the top market players in Italy, Austria, Poland and Germany. In the CEE region, UniCredit operates the largest international banking network with around branches and outlets, and is a market leader. Foreword UniCredit is seriously concerned about the foreseeable implications of the IOSCO proposed principles on markets functioning. In particular: 1) with reference to the key issue of using real transactions data versus estimations, UniCredit believes that there is no ideal or one size fits all approach. The proposed IOSCO framework seems to assume that a transaction based benchmark is per se more credible and reliable than an estimation-based one, regardless the underlying market features and conditions. If that is the case, UniCredit wishes to bring to IOSCO attention that current money market in Euro area is experiencing a critical lack of liquidity while unlevel playing field conditions are challenging the participating EU Member States. The transition to a transaction-based mechanism would not likely produce a suitable replacement of the existing - well accepted - benchmarks, such as the Euribor. A transactions-based benchmark will be credible, reliable and robust provided the underlying liquidity is granted upon all market conditions, with proper fall-back provisions in case of missing data. In this regard a group of European leading market participants is working on the feasibility to promote a market-led initiative aiming at strengthening the functioning and resilience of the unsecured money market (Short Term European Paper - STEP) and its infrastructure. 2) With reference to the implications on the market resilience and functioning as well as on financial innovation, UniCredit raises concerns over the tangible consequences that the proposed framework are likely to produce on all index administrators and on the panel participation of contributors. The proposed framework may also constitute a serious impediment to financial innovation. Therefore, UniCredit strongly encourages all competent authorities, and specifically IOSCO, to: - carry on an impact assessment with a view to examine the overall impact the proposed principles are likely to produce on the real economy and financial markets ; and - act as catalyst for the market-led initiative which is intended to enhance market liquidity in the unsecured money market segment (Short Term European Paper - STEP) with a view to stake out

2 the ground for building reliable and robust benchmarks, under both normal and stressed conditions. General and key UniCredit considerations on the impact if the IOSCO principles were to be applied Transaction-based or estimations-based indices 1? With reference to the key issue on whether to use actual trade data or submission of estimates, UniCredit deems that there is no ideal solution. Some benchmarks may suit the best when considering actual data whilst others are more meaningful when based on submissions of estimates. UniCredit regards that actual data-based indexes are to be preferred when markets are extremely liquid and homogeneous (i.e. no tangible difference among different submitters). In this case, a robust governance and constant market liquidity would help to reduce the risk of market manipulations. On the other hand, estimates are to be preferred when market is illiquid or disrupted or when real transactions seldom take place, as it is currently the case for the interbank lending market in the Euro area. Where such conditions occur, then estimates (on which Euribor is based) are more appropriate. In fact they provide a genuine assessment of the view one submitter has on markets levels regardless the status of each submitter in terms of credit rating and location. Before recommending the implementation of substantial changes to systemically important benchmarks, UniCredit would ask IOSCO to carefully assess possible consequences and implications on the legal and the operational field. Leading to a non sustainable business model for estimation-based indices? UniCredit considers that the proposed IOSCO framework would be likely to lead to a substantial increase of costs, liabilities and risks for administrators. Due to the higher entry barriers, the setting up and/or the management of benchmarks and indices might become sustainable just for a few number of large entities. In UniCredit view, the adverse effects of these extra costs might be ultimately charged on both the retail and corporate sector,directly or indirectly through a less efficient financial market. Royalties and fees for using those specific benchmarks or indices (e.g. Euribor) would have to be borne by all users as a part of the externality brought by the increased governance costs. 1 In this UniCredit reply to IOSCO, the benchmarks based on transactions are opposed to those based on estimates. See also reply to question 4 for further details 2

3 What is the most likely market reaction, ceteris paribus? As soon as the market will perceive that the proposed principles will be enforced, also in the long term, market participants are likely to abruptly adjust. UniCredit considers that the overwhelming indices and benchmarks business produced by private entities (both for profit and non for profit) will no longer be sustainable and that there will be limited scope for financial innovation, which often is driven by indices. Under the most likely scenario, most index administrators, and not only index contributors, would rush to disengage from managing benchmarks. The proposed principles may lead to the disappearance of many (if not all) indices that are not transaction-based (an possibly also some of the latter) or whose administrators have not a large enough structure to bear the added costs. Some policy-makers might argue that this new equilibrium is the best one as they deem the transactionbased indices as the most suitable solution. UniCredit disagrees with the one fits all approach as such a regulatory solution may constrain the financial system to have only few transaction-based indices which cannot work properly with limited (or no) liquidity. UniCredit underlines that transaction-based benchmarks are more prone to be manipulated when they are based on an illiquid market than estimation-based benchmarks (provided that a sound governance is in place). UniCredit encourages all stakeholders to focus on structural enhancements of the financial markets functioning and liquidity, under normal and stressed conditions. What is the most likely future scenario if IOSCO principles were to be applied? UniCredit envisages a global oligopoly with 2-3 major benchmark providers (something like the credit assessment activity with few Rating Agencies ). Due to the higher entry barriers and the limited business rationale, the task will end up, for many indices, to be performed by the public authorities, as it was the case some decades ago in less developed financial markets. The concern is that once reached, the new equilibrium will be likely to become a stable albeit suboptimal situation. What could be the role of competent authorities? UniCredit encourages the competent authorities to: - undertake an impact assessment in terms of the business model they are shaping; - possibly act as catalyst and sponsor for those initiatives which try to promote market liquidity in certain relevant markets therefore allowing the setting up of resilient benchmarks. Furthermore, in order to ensure that: i) forms of market manipulation of money market indices are properly tackled, ii) information quality is enhanced and iii) index continuity is managed, it would be advisable, at least for certain critical benchmarks such as Euribor, to investigate some concrete microstructure financial market changes. For instance it should be considered the feasibility of a "concentration of trading" on one or few electronic platforms, also promoting incentives to produce appropriate and standardised statistics to an entity / data warehouse which satisfy certain features of 3

4 independence and reliability. In this regard a group of European leading market participants is working on the feasibility to promote a market-led initiative aiming at strengthening the functioning and resilience of the unsecured money market (Short Term European Paper - STEP) and its infrastructure. UniCredit answers to specific questions 1. Equity indices: are there any principles or parts of the principles that cannot, or should not, be applied to equity indices? If so, please identify these principles and explain why their application is inappropriate. When applied to equity indices, notably when equity indices are based on highly liquid and public data from Regulated Markets, the application of the controls should be properly tailored to the market conditions, in order to avoid undue increase of costs. Please find below some examples of principles potentially not applicable to equity indices: the oversight of the submissions by a separate and independent function (Principle 5); the concept of data sufficiency (Principle 7); guidelines regarding the hierarchy of data inputs and exercise of the expert judgment (Principle 8); the set up by the Administrator of criteria for including/excluding Submitters (Principle 10); the develop by the Administrator of a Submitter Code of Conduct (Principle 13). With particular reference to the proposed Principle 4 (Control Framework for Administrators), the activity of Administrators aimed at ensuring integrity of inputs i.e. selection of submitters, code of conduct, frequency of inputs - can be considered already covered under the mandatory regulation of the Regulated Markets/Stock Exchanges. While the a further step of verification could be not necessary, an ex-post analysis of trends and outliers expressed by market data could represent an alternative measure to ensure the required double check of inputs. In light of the above, UniCredit finally highlights that a flexible application of these principles should cover the process of submission of inputs but not also the calculation and the use of benchmarks. 2. Additional measures to address risks resulting from Submission-based Benchmarks or ownership or control structures: a. Should these additional requirements apply to Submitters and Administrators of all submission-based Benchmarks or Benchmarks with the specified ownership/control structures? 4

5 1. Principle 13, point e : in order to discourage the Submitters withdrawals from panels, the Administrator should be allowed to sanction publicly those counterparties. It is noted that not all Administrators are in the position to do so. Specifically, those benchmarks sponsored or managed by Regulators/Central Banks (e.g. respectively CDOR, STIBOR) can have a tighter sanctioning policy should a misbehaviour occurin respect to others benchmarks, administered by Associations or other entities (e.g. Euribor, EONIA, BBSW) 2. Principle 13, point g sub xi ; prohibitions on the submission of data from front office functions ; Such a provision would be able to actually jeopardize the integrity of those contributed benchmarks. Professional skills and expertise are key factors for a reliable and credible benchmark; it is considered that having non-front office contributions would be detrimental to the credibility and robustness of estimation-based benchmarks. b. If not, please explain why all or some submission-based Benchmarks or Benchmarks with the specified ownership/control structures should be exempt. See also reply to question a. above More in general, UniCredit deems that any additional requirement aimed at mitigating risks connected to the submission-based Benchmarks and to the ownership/control structures should be proportionate to the form and the vulnerability of data inputs and the inherent conflicts of interest where Administrators play the role of experts (i.e. perform an expert judgment). In this respect, UniCredit strongly supports the proposed approach according to which there should be no expectations regarding a one size fits all method of implementation to achieve the objectives underlined to the proposed principles. 3. Notice Concerning Use of Expert Judgment: Should Administrators be required to briefly describe and publish with each benchmark assessment: a. a concise explanation, sufficient to facilitate a User s or Market Authority s ability to understand how the assessment was developed, terms referring to the pricing methodology should be included (e.g., spread-based, interpolated/extrapolated or estimate-based); and UniCredit deems that this topic should be addressed at the single benchmark s Code of Conduct level b. a concise explanation of the extent to which and the basis upon which judgment (i.e. exclusions of data which otherwise conformed to the requirements of the relevant methodology for that assessment, basing assessments on spreads, interpolation/extrapolation or estimates, or weighting bids or offers higher than concluded transactions etc.), if any, was used in establishing an assessment. Under the UniCredit view, both these topics should be addressed at the single benchmark s Code of Conduct level, also by ensuring an adequate discretionary margin for administrators with regard to the setting up of format and content of the concise explanation required for noticing the use of expert judgment. 4. Revisions to the principles: Please provide any suggested changes to specific principles or definitions 5

6 of key terms set out in Annex A, including drafting proposals and rationale. Regarding the conflicts of interests mentioned in principles 3, 4 and 5, UniCredit highlights the importance to make reference to a proportionality principle since the relevant activities/processes aimed at managing such conflicts (e.g. segregation of reporting lines within the administrator, implementation of internal policies, set up of ongoing controls) may be hard to apply in smaller structures, due also to the likely high costs involved. With reference to principle 9 (Periodic Review), UniCredit suggests to specify, where an oversight function is established according to principle 5 (Internal Oversight), that process rules should cover the allocation of tasks and responsibilities between the Administrator and the internal oversight functions (e.g. responsibilities for first level controls i.e. embedded in the process itself). As to Principle 13, the Submitter Code of Conduct, although detailed, does not fully specify the need to have internal procedures to ensure periodic internal audits on the submissions and the implementation of systems for the timely delivery of submissions. As for Principle 13.g ) it could be consider to add with regard to the conflict of interest, rules that are designed to prevent collusion among submitters.; Referring to principle 16 (Audit), UniCredit suggest to add, at the end of the second subparagraph, the following sentence: and proposing corrective measures, where necessary. As far as definitions of key terms set out in Annex A are concerned, UniCredit would stress the need to have a clarification on the terminology clear definitions to be used for benchmarks. In light of above, UniCredit believes that the Benchmark Publisher definition should quote also the users, further to Subscribers, as subjects to which benchmarks are made available. Moreover, under the IOSCO glossary, Submissions are defined as Prices, values, rates or other information that is provided by a Submitter to an Administrator for the purposes of determining a Benchmark. Such a definition seems not to narrow the line between transaction-based and submission-based benchmarks. In EU there are indices such as Euribor which are based on estimates and others such as EONIA which are otherwise based on transactions. Both are built upon submissions from the contributing firms. It is therefore suggested to provide for a clarification of the definition. As far as definitions set out in Annex A are concerned, UniCredit believes that the Benchmark Publisher definition should quote also the users, further to Subscribers, as subjects to which benchmarks are made available. Are any other principles needed: Should principles to address any additional issues, risks or conflicts of interest be developed? Please provide a summary of the issue and drafting for the proposed principle. UniCredit would suggest to evaluate the opportunity to develop principles for users of benchmarks as those set out under the EBA-ESMA joint consultation document on Principles for Benchmarks- Setting processes in the EU (January 2013) where it is provided that Benchmark users should regularly assess the benchmarks they use in financial products or transactions, and verify that the benchmark used is appropriate, suitable and relevant for the targeted market. Any potential irregularities observed in a benchmark should be notified to the benchmark administrator or the relevant competent authorities if appropriate. 6

7 Contact people ( name.surname@unicredit.eu ) Please find below the list of the key contact-people involved in this work, whose contribution made possible to coordinate and provide UniCredit answers to this Consultation. Some other experts have been involved alongside the UniCredit Group, but are not listed below. Coordination Team and Contributor European and Regulatory Affairs / Public Affairs Costanza Bufalini Head of European and Regulatory Affairs Laura Esposito Institutional Relations with EU Marco Lagana Regulatory Affairs Andrea Mantovani Regulatory Affairs Other Contributors Group Treasury Pier Mario Satta Head of Group Treasury Alberto Covin Short Term Funding & Interest Rate Management Global Regulatory Counsel Antonio La Rocca Co-Head of Global Regulatory Counsel Francesco Martiniello Head of Global Financial Services Counsel Patrizia Della Mura Global Financial Services Counsel 7

By to: Principles for Financial Benchmarks Consultation Report

By to: Principles for Financial Benchmarks Consultation Report 16 May 2013 Mr Alp Eroglu IOSCO Calle Oquendo 12 28006 Madrid Spain By e-mail to: BenchmarkPrinciplesconsultationresponses@IOSCO.org Dear Mr Eroglu Principles for Financial Benchmarks Consultation Report