Am I a benchmark user?
You are "using" a benchmark if you do any of the following things:
- Provide a borrowing rate that is a mark-up over an index.
- Measure the performance of an alternative investment fund ("AIF") or an undertaking for collective investment in transferable securities ("UCITS") against an index - whether that measurement is for the purpose of tracking the return of the index, setting portfolio asset allocations, or calculating performance fees.
- Determine the amount payable under certain types of consumer credit agreement by reference to an index.
- Determine the amount payable under a financial instrument by reference to an index.
- Issue or are party to a financial instrument that references an index.
The following firms are therefore likely to be "users" of benchmarks:
- Banks or lenders offering mortgages or consumer credit at an index-based rate (e.g. "LIBOR + 1%").
- Managers of AIFs or UCITS (including delegated portfolio managers) where asset allocation, returns or fees are linked to an index.
- Issuers of financial instruments that reference an index (e.g. a structured product or derivative based on FTSE performance).
- Parties to a financial contract that references an index.
However, merely holding a financial instrument that references a benchmark does not amount to "use" of a benchmark, so the end investor will not be a benchmark user.
What is meant by an "index" in this context?
An "index" is any figure that is:
- published or made available to the public, and
- regularly determined (either wholly or in part) by the application of a formula, an assessment, or any other method of calculation, on the basis of one or more underlying assets or prices (including estimated prices, actual or estimated interest rates, quotes and committed quotes, or other values or surveys).
What do benchmark users need to do?
Although the Benchmarks Regulation mainly affects benchmark administrators and contributors, there are a few provisions that benchmark users will be required to comply with. In particular:
- Supervised entities (broadly, regulated firms) may only use benchmarks if the benchmark or its administrator appears on a register of eligible benchmarks that will be maintained by the European Securities and Markets Authority ("ESMA").
- Supervised benchmark users also must have "robust written plans" for what they would do if a benchmark materially changes or ceases being provided, which must be reflected in client-facing terms and provided to the firm's regulator upon request.
- Prospectuses regarding investment products that reference a benchmark must state whether the benchmark is provided by an administrator included on the ESMA register.
- Where credit agreements that are within the scope of the Consumer Credit Directive or Mortgage Credit Directive make reference to a benchmark, the agreement must identify the benchmark and its administrator and the potential implications for the customer. For consumer credit agreements, this must be in a separate document, which may be attached to the Standard European Consumer Credit Information Form.
What are the penalties for non-compliance?
National competent authorities will have the power to impose a range of sanctions, including fines and non-financial sanctions, for infringements of the Benchmarks Regulation or failure to co-operate with an investigation. For instance, they will be able to make 'cease and desist' orders, order the disgorgement of gains arising through a breach, and issue public warnings. The maximum financial penalties for a breach of the requirements applicable to benchmark users will be at least €500,000 for individuals, or the higher of €1 million or 10% of total annual turnover for companies and other legal entities. Member States may also grant their competent authorities powers to impose higher levels of sanctions, or may elect not to impose administrative sanctions where infringements are subject to criminal sanctions under their national law.
Although the maximum penalties are very high, national competent authorities will be required to take into account all relevant circumstances when determining the appropriate type and level of sanction to be applied to a particular infringement. This will include taking into account, for example, the gravity and duration of the infringement, the level of cooperation of the responsible person with the competent authority, any previous infringements and any measures taken to prevent the infringement being repeated.
What if the benchmark I am using is not on the ESMA register by 1 January 2017?
Transitional provisions allow EU administrators to continue providing an existing benchmark until 1 January 2020. Supervised entities may continue to use the existing benchmark during that period unless the benchmark administrator has applied to its regulators to become authorised or registered and that application has been refused.
Authored by Michael Thomas, Neelam Hundal and Bianca Smith-Moir