COMMISSION STAFF WORKING DOCUMENT EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT Accompanying the document Proposal for a Regulation of the European Parliament and of the Council on indices used as benchmarks in financial instruments and financial contracts
Date: 2013-09-18
Institutions: European Commission
Subjects: Euribor, consumer protection, domestic market, financial control, financial legislation, financial market, price index, statistical method













EUR-Lex - 52013SC0337 - EN











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52013SC0337

COMMISSION STAFF WORKING DOCUMENT EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT Accompanying the document Proposal for a Regulation of the European Parliament and of the Council on indices used as benchmarks in financial instruments and financial contracts /* SWD/2013/0337 final */










1.
introduction

An index is a
statistical measure, typically of a price or quantity, calculated from a
representative set of underlying data: when this index is then used as a
reference price for a financial instrument or other financial contract it becomes
a benchmark. A wide variety of benchmarks are currently produced. These
benchmarks differ not only in the underlying data used, but also in the methods
used to collect the data, the calculation of the index and their ultimate use.
The benchmark industry generates around EUR 2
billion in revenues for financial and commodity benchmark administrators
world-wide. Estimates suggest that the size of the markets impacted could be
over EUR 1,000 trillion. The recent alleged manipulation of the interest
rate benchmarks LIBOR and EURIBOR has highlighted both the importance of
benchmarks and their vulnerabilities. The integrity of benchmarks is critical
to the pricing of many financial instruments, such as interest rate swaps and
forward rate agreements, and commercial and non-commercial contracts, such as
supply agreements, loans and mortgages. They also play an important role in
risk management.
The integrity of benchmarks was the focus of the
Wheatley Review of LIBOR and the subsequent regulation of LIBOR in the United Kingdom, as well as of the regulation of CIBOR in Denmark. The EBA and ESMA published
Principles for Benchmarks-Setting Processes in Europe on 6 June 2013 that
provide guidance to participants in the gap before any Commission initiative
comes into force. The EBA also carried out a review of Euribor and published recommendations
to the EBF-Euribor in January 2013. In addition, the European Commission is undertaking
investigations into a possible cartel in relation to EURIBOR and into a
potential case of collusion by contributors to price assessments for oil and
biofuels by some commodity price reporting agencies.
The FSB is coordinating the international
approach on benchmark reform. At its request, IOSCO published Principles for
Financial Benchmarks in July 2013. Previously, IOSCO had published Principles
on the oversight of oil price reporting agencies in October 2012. Further work is
being conducted at FSB, G20 and BIS level.

2.
problem definition
2.1 Risk of benchmark manipulation

Benchmarks
directly affect the value of the financial instruments and other contracts
which are referenced to them. Manipulating the value of a benchmark therefore
results in a direct transfer of money from one of the contracting parties to
the other. The risk of manipulation
observed in many benchmarks is driven primarily by the discretion submitters
have when selecting data for submission to the calculator or when assessing
their submissions, and the discretion that administrators exercise when
calculating the benchmark. Some benchmarks rely exclusively on assessments from
contributors, with little possibility for ex post verification against real
data. The provider may not be able to verify whether these submissions are
representative and applies discretion in assessing or calculating the benchmark
on the basis of this data.
Moreover, contributors
may choose to submit only a subset of their data, which hurts the accuracy of
the benchmark. Contributors may also be reluctant to provide complete or
accurate data to benchmark administrators if this conflicts with other
interests, such as disclosing sensitive or confidential commercial data or
information which acts as a signal to other market participants. Conflicts of
interest exist in particular where the contributors or administrators are also
the users of the benchmark. Contributors may submit insincere estimates, or
false or partial data which do not necessarily reflect true market conditions,
when they are able to profit by changing the benchmark.
Where an index is
published, its use may become so widespread that it becomes critical, or at the
least any failure will have significant impact on markets and investors.
Finally, most authorities do not have supervision and enforcement powers over
the setting processes and actors, which prevent the effective oversight of
benchmarks and enforcement of compliance with minimum standards in their
provision.

2.2. Use of benchmarks which are not robust, reliable or
fit for purpose

Where a benchmark is not
robust and is subject to the risk of manipulation, its use may harm investors
or other users.  More sophisticated users, such as banks and other wholesale
market participants, may have a good understanding of the risks posed by the
benchmarks’ lack of robustness and absorb this risk, or be able to take
appropriate mitigating measures. However retail consumers may not be fully
informed of the nature of the benchmark to which a financial contract they
enter into is referenced and may not have any choice about the benchmark used.
The problem
of the use of benchmarks which are not robust, reliable or fit for purpose is
mainly driven by the lack of transparency about the purpose of benchmarks and
the lack of suitability of benchmarks for their intended purpose, particularly
for retail financial contracts.
Benchmarks measure a
particular market or economic reality. However, in many cases, there is a lack
of transparency about what exactly a benchmark is intended to measure, in
what circumstances it provides a reliable measure and about other risks
associated with its use. If this transparency is lacking, users may not be able
to make appropriate decisions about which benchmark to use. When this occurs,
economic decisions will be based on distorted values, leading to a less than
optimal allocation of assets and potential losses for investors and consumers. 
Often benchmarks are
used to reference consumer contracts without sufficient or appropriate
assessments of their suitability for this purpose. Even benchmarks which
adequately measure the economic reality which they are intended to represent
may have a harmful impact when used for other purposes. This problem is driven
by a lack of understanding on the part of those entering into contracts
referenced to them, especially when they are retail investors or consumers. Often
markets use benchmarks not based on their suitability, but simply because network
effects make a particular benchmark the established unit of measure.
Similarly, unequal bargaining power or the use of standard terms and conditions
mean that choice of an inappropriate benchmark may be imposed on one of the
counterparties.  There may also be significant conflicts of interest in strategy/proprietary
indices which are used or produced by fund managers who have direct interest in
the performance of these funds. 

3. Subsidiarity and
proportionality

While some
benchmarks are national, the benchmark industry as a whole is international in
both production and use. For benchmarks that are widely used or produced across
several Member States national action may lead to fragmentation of the internal
market and could facilitate regulatory arbitrage, as benchmark production can
be easily moved to other Member States. By contrast, an EU initiative would
help enhance the single market by creating a common framework for the use of reliable
and suitable benchmarks across different Member States. EU action is therefore
in line with the principle of subsidiarity.
The principle of
proportionality requires that any intervention is targeted and does not go beyond
what is necessary to achieve the objectives. At the identification of
alternative options, as well as throughout the analysis and comparison of
options and their scope, the proportionality principle has been guiding the
process. This has been achieved in two ways: firstly, by targeting only those
benchmarks that may have a direct and certain economic impact if they are
manipulated and secondly, by identifying measures which by their nature do not
involve issues of proportionality or, where measures might impose a
disproportionate burden, enabling those measures to be calibrated in a
proportionate fashion. 

4.
Scope 

The scope of the
proposal has been determined by reference to the problems outlined above to
ensure that the problems are effectively, efficiently and proportionately
addressed.  The proposal’s scope is determined in a two-step approach: first by
reference to which benchmarks (“targeted benchmarks”) are covered and secondly,
which activities in relation to these targeted benchmarks should be covered.  
First, all published indices
which are used to reference the price of a financial instrument or contract or
measure the performance of an investment fund are covered since these are the
benchmarks whose manipulation will cause financial loss and which are most
susceptible to the problems outlined.
Second, all benchmark administrators
producing these benchmarks based in the Union are within scope, as administrators
are subject to all the problems outlined above. Central banks are exempt from
the scope as they already respect a high level of integrity and are subject to
control by public authorities. Contributors based in the Union are also subject
to these problems but according to the analysis it is only proportionate to
target contributors that are already subject to EU financial regulation. The
main reason is that the compliance burden would mean that currently unregulated
contributors could potentially cease to contribute and in any event could not
be effectively supervised by financial regulators.

5.
objectives

The
table below provides an overview of the general, specific and operational
objectives of this initiative in light of the analysis of the risks and problems
above:
 General objectives || Specific objectives || Operational objectives || Measurable objectives 
 1)  Restore confidence in financial markets 2)  Enhance market integrity and fairness; ensure that financial markets serve the real economy 3) Ensure consumer and investor protection ||  Ensure benchmarks’ integrity: 1.  Reduce the risk of benchmark manipulation 2) Ensure the appropriate use of robust and reliable benchmarks || 1) Limit incentives and opportunities for manipulation 2) Minimise discretion - ensure benchmarks are based on sufficient and representative data 3) Ensure robust governance and controls address risks 4) Enhance transparency and the use of suitable benchmarks 5) Ensure effective oversight || 1) Reduce the number of benchmarks vulnerable to manipulation 2) Increase the number of benchmarks based on sufficient and representative data 3) Reduce the number of findings of inappropriate governance and controls 4) Increase the number of statements on benchmarks purpose and assessments of suitability for retail use 5) Reduce the number of cases of benchmark manipulation 

6. policy options and
analysis of the impacts

The different policy options were tested against
the criteria of their effectiveness and efficiency in achieving the six
operational objectives. 

6.1. Limit incentives and opportunities for manipulation:
 
 Policy options 
 1 No action 
 2 Manage and disclose conflicts of interest 
 3 Structural separation 
Option 2 is the preferred option: structural
separation is effective in limiting the opportunities for manipulation, but it would be
disproportionate in many cases, as it could discourage benchmark provision and
lead to the discontinuation of some benchmarks. Managing and disclosing
conflicts of interest creates the incentives for those performing
calculations or submitting information to benchmarks to do so in an objective manner.
Thus, it encourages accurate submission of data and honesty in the data
validation process. 

6.2. Minimise discretion; ensure
benchmarks are based on sufficient & representative data:
 
 Policy options 
 1 No action 
 2 Require the use of transaction data if available and reliable, otherwise well founded and verifiable discretion 
 3 Mandatory use of transaction data only if necessary 
 4 Mandate contributions for critical benchmarks 
Options 2 and 4 are the preferred options: a rule
requiring that representative transaction data take precedence, and that the
use of other data needs to be verifiable, provides an instrument
for ensuring that benchmark rates and contributions are based on sufficient and
representative data and that discretion is justified, well founded and properly
exercised. Thus, it enhances the reliability of benchmarks and transparency of
the process. The power to mandate contributions to critical benchmarks ensures
the continuity of benchmarks which are of critical importance when there is the
risk of contributors ceasing their contributions. It also ensures that they are
based on sufficient samples of market data, particularly in times of market
stress when contributors may be reluctant to submit data or estimates for
benchmark calculation.

6.3. Ensure robust governance and controls address risks:
 
 Policy options 
 1 No action 
 2 Supervisory authorities to issue comply or explain guidelines 
 3 Mandate adequate management systems and effective controls 
Option
3 is the preferred option: given the inherent conflicts of interest in
making contributions to and calculating benchmarks, comply or explain
principles are not likely to achieve the desired results. Mandating
adequate management systems and effective controls provides a tool for enforcing
robust governance and controls necessary to address the shortcomings identified
in benchmark provision and contribution activities. 

6.4. Enhance transparency and ensure the use of robust and
reliable benchmarks: 
 
 Policy options 
 1 No action 
 2 Require transparency on methodology, underlying data, process and purpose, whilst allowing for delayed or partial transparency of underlying data when justified 
 3 Assessment of suitability of benchmarks’ use for retail contracts 
 4 Mandatory notification of benchmarks use 
Options 2 and 3 are the preferred options: transparency
on data and methodology would allow both the regulators and the public to
evaluate whether the benchmark is accurate and reliable. With access to both
the data and the methodology, investors and regulators would be able to
replicate or back test the benchmark in order to assess its accuracy. Full
transparency about what the benchmark measures, how it should be used and its
shortcomings would enable regulators and the public to be fully informed about
the economic reality a benchmark is intended to measure and of any shortcomings
it may have in tracking this. Delayed publication or partial publication would
be allowed if full and contemporaneous publication would result in serious
adverse consequences for the contributors or adversely affect the reliability
or integrity of the benchmark. Publication would only be permitted to be
delayed to the extent it significantly diminished these consequences. Where a
regulated entity such as a bank intends to enter into a financial contract with
a consumer, where the payments are referenced by a benchmark, it should assess
the suitability of the benchmark for this use and warn the consumer if it is
unsuitable. 

6.5. Ensure effective supervision of benchmarks:
 
 Policy options 
 1 No action 
 2 Private benchmark provision, independent private oversight 
 3 Private benchmark provision, public supervision and enforcement 
 4 Public provision of critical benchmarks 
Option 3 is the preferred option: public provision
of benchmarks may hinder innovation and may also be subject to conflicts of
interest. Private oversight may also be subject to conflicts of interest.
Making the provision of benchmarks a regulated activity ensures the supervision
of benchmark administrators to the highest possible level. It would thus
provide authorities with a tool for enforcement of compliance and
accountability of administrators and contributors. It would ensure the
independence of the supervisor as it would be a public authority and allow for
market choice, innovation and competitiveness as benchmark provision would
remain in private hands.
Supervision
of administrators would be carried out by the national supervisory authorities
under the coordination of ESMA. For critical benchmarks, supervision by a
college of national supervisors would be mandatory. ESMA would participate is
the colleges of supervisors for critical benchmarks and exert binding mediation
when necessary. Supervision of contributors would be exercised by their current
supervisors. 

7.
Impacts of the preferred options package

The chart below administrators
a summary of the retained policy options 
 Operational objective   || Preferred policy options 
 Limit incentives and opportunities for manipulation  || Manage and disclose conflicts of interest 
 Sufficient data and minimised discretion || Transaction data if available and reliable, otherwise well founded and verifiable discretion 
 Mandate contributions for critical benchmarks only if necessary 
 Ensure robust governance and controls address risk || Mandate adequate management systems and effective controls 
 Enhance transparency and ensure the use of benchmarks which are robust, reliable and fit for purpose || Require transparency on methodology, underlying data, process and purpose, whilst allowing for delayed or partial transparency of underlying data when justified 
 Assessment of suitability of benchmarks’ use for retail contracts 
 Ensure effective oversight || Private benchmark provision, public supervision and enforcement 
The main goal of this initiative is to enhance
the robustness and integrity of European benchmarks by reducing the risk of
benchmark manipulation. Thus, it will contribute to enhancing market integrity
and fairness and to restoring confidence in financial markets. This initiative
also aims to ensure the appropriate use of robust and reliable benchmarks,
which will enhance consumer and investor protection and assure that financial
markets serve the real economy.

8.
Monitoring and evaluation

The
evaluation of the consequences of the application of the legislative measure
could take place three years after the entry into force of the legislative
measure, in the context of a report to the Council and the Parliament on the
effectiveness of the legislative initiative and appropriateness of the sectoral
approach.