The road to BMR authorisation for a third country benchmark is difficult, time-consuming and costly. Many third country benchmark administrators have been slow to grasp the implications of BMR for their benchmarks. BMR and its accompanying ESMA Technical Standards are extensive and complex.
As a result, some third country benchmark administrators are considering ignoring BMR as they deem it unnecessary for the following reasons:
- Their benchmark was developed for local use
- EU Supervised Entity investment in their benchmark or related products is not needed
- The cost/benefit analysis of meeting BMR does not warrant the implementation of the authorisation process
In some cases, this reasoning may be sound, assuming that the benchmark administrator responsible for the benchmark has all the correct information about their benchmark use to make the right decision. But in many cases choosing not to authorise a third country benchmark may have unintended negative consequences.
Investment flows from EU Supervised Entities
When a third country benchmark administrator decides not to apply for authorisation, EU Supervised Entities, by law, cannot invest in the benchmark or products that use these benchmarks past 1st January 2020.
The question to ask is ‘how many EU Supervised Entities use the benchmark or may have a legacy contract in place that requires ongoing reference to the benchmark?” More importantly, will the restriction of investment from the EU negatively impact local financial market organisations and restrict future business opportunities?
From our experience many benchmark administrators have a limited view of who uses their benchmarks and for what purpose they use them. At GRSS we have practical experience in converting freely available benchmarks to licensed fee liable benchmarks. Over the past 10 years we have seen that the bulk of benchmark users are located outside of the benchmark country. Initially the benchmarks were produced for local consumption, but the nature of international commerce and the interconnectedness of markets has meant that benchmarks are now an international commodity.
It is a risky strategy for third country benchmark administrators to ignore BMR given the potential for disruption for local and international investors. The unforeseen consequences for an unauthorised third country benchmark past January 2020 could be terminal for the benchmark even when the wish was to just continue with the benchmark for local consumption only.
Investment flows from other jurisdictions
BMR, while EU centric and only applying to EU Supervised Entities, will ultimately affect investment decisions by other investors in other countries. BMR is being seen as a bellwether for “best practice” benchmark administration and it is likely that investment firms, other than EU Supervised Entities, will seek to use the ESMA Benchmark Register as a guide to identify benchmarks that are well governed for their future investment decisions.
A third country benchmark administrator that decides not to get their benchmark onto the ESMA Benchmark Register, purely taking into account EU Supervised Entity investment flows, may be surprised. Unintended consequences could include market disruption, disgruntled local and international investors and ultimately the demise of the benchmark.
Once investment decisions are made to not use a benchmark, it would be difficult to recover these investment flows.
How to get authorised under BMR
There certainly are ways to get authorised under BMR that will allow these investment flows to continue, market disruption and the possibility of cessation being avoided.
The answer may lie in taking a different route to achieving the end result.
There is a great deal of work required to obtain BMR authorisation either via the Equivalence, Recognition or Endorsement pathway. Many financial market associations (current benchmark administrators) do not have the resources, expertise, time or funding to take on this endeavour.
One solution is to divest the benchmark to a professional benchmark administrator, like GRSS, who has all of the expertise, technology and BMR related artefacts to enable authorisation to be completed in time. Furthermore, GRSS has the capability to put in place funding options to allow the benchmark to be self-sufficient in the future.
A more poignant question at this time is whether the current administrator (association, exchange, co-operative etc) is best suited to operate the benchmark. Key questions that administrators should ask are:
- Is this our “core” competency?
- Do we wish to be regulated for this activity?
- Are we an organisation that can act as a ‘regulatory agent’ in our oversight of input data contributors?
- Is our main business benchmark administration?
- Do we have adequate resources and expertise to continue this activity?
- Is this a cost to us with no obvious return?
- Are we happy with the risks attached with this activity?
Cake and eat it too
If the answer to any of the questions above is ‘no’, then it would be worth looking at alternative options.
If the divestment route is taken then the optimum outcome would be that the benchmark continues with the same original benefits to the local market but administered by a specialist administration firm. A firm, such as GRSS, that is set up to perform the administration in accordance with the IOSCO Principles and BMR, with appropriate oversight, stakeholder engagement and risk management.
At GRSS we believe that this is achievable and that a current benchmark administrator can have their cake and eat it too.
A professional benchmark administrator, like GRSS, will work closely with the current administrator to make the transition and provide confidence to all stakeholders including central banks, competent authorities and the investment community that all interests are being served.
The current benchmark administrator can still be heavily involved in the development of the benchmark – in fact, their involvement is paramount.
This is a vital component to any decision. The new benchmark administrator needs to be completely independent and without conflicts of interest. The administrator should not be a user of the benchmark, a distributor of the benchmark or have any financial exposure to the level of the benchmark.
GRSS is a fully independent benchmark administrator, with no links or ties with any secondary use. The purpose of GRSS is to serve the users of benchmarks while meeting all necessary regulatory requirements.
Under the divestment model, the entire benchmark would be divested to GRSS who would take on the responsibility of obtaining BMR authorisation for the benchmark by 1st January 2020.
The existing benchmark administrator would no longer have any responsibility for the benchmark.
While this would suggest that the existing local market loses some sense of control over the benchmark – this is very far from the reality. The participation of the contributors, industry members, infrastructure providers and the general pubic are all critical to the ongoing success of the benchmark or any alternatives to it.
There is a clear delineation from operating the business of benchmark administration, and the determination of a benchmark’s future direction. GRSS is a professional benchmark administrator and can operate the benchmark for the benefit of all local stakeholders. The benchmark oversight committee would comprise of local representatives which may have a surprisingly similar membership to the current oversight committee.
Under this scenario, the benchmark administrator and GRSS enter a joint venture agreement to operate the benchmark. GRSS would provide all of its expertise and systems to operate the benchmark in accordance with BMR to achieve authorisation by 1st January 2020.
The primary difference between the joint venture/partnership model and divestment is that under a joint venture or partnership the existing benchmark administrator may be able to offer some of its resources to assist in the administration effort.
IP Licensing/Term licensing
Under an IP Licensing scenario, the current benchmark administrator can retain the existing IP to the benchmark and allow GRSS to operate the benchmark using this IP while paying some form of annuity for its use.
The other option is for the current administrator to license GRSS to operate the benchmark for a period of time. This option may appeal if the administrator believes it may wish to take the administration role back from GRSS at some time in the future.
The consequences for a third country benchmark administrator that chooses to ignore BMR may be severe, and in a worst-case scenario lead to the eventual demise of the benchmark. A lesser impact could be some market disruption due to reduced international investment flows.
Benchmark administrators may not have the capability to move their benchmark to authorisation under BMR or may not have the appetite to assume additional risks. Rather than ceasing the benchmark, an option to consider is to divest the benchmark either fully or in some capacity – allowing a professional benchmark administrator such as GRSS to put in place the systems and technology to allow BMR authorisation to be achieved.
Whatever route an existing benchmark administrator chooses to take the oversight of the benchmark will remain similar to its current make-up – operated by local representatives and stakeholders. It is recommended that the new benchmark administrator needs to be independent and guided by the needs of the users of the benchmark, wherever they may be. Administrators should not be guided by political or secondary considerations in the carrying out of their duties.
The transition of a benchmark to a professional organisation, like GRSS, set up to manage the regulatory risk, technology and governance challenges may be the best option for current benchmark administrators. Such a transition would certainly allow the benchmark to continue long term, reduce the current administrator’s risk and facilitate the benchmark onto the ESMA Benchmarks Register ahead of the January 2020 deadline.