From 1 January 2018 onwards, the European Union’s Benchmarks Regulation (BMR) will apply to all administrators of, contributors to and users of indices that serve as financial benchmarks. Asset management firms all over the western half of Europe should be preparing for it now.

The BMR represents a massive change in the regulation of financial benchmarks and will revolutionise the operations of most European asset management organisations. This article is a brief guide to the things they ought to be considering and doing.

Why is the BMR necessary?

Trust in benchmarks, which ought to be the keystone of the global financial services industry, has been undermined by a series of high-profile rate-rigging scandals. The manipulation of important interest-rate benchmarks, including the London Interbank Offered Rate (LIBOR), the Euro Interbank Offered Rate (EURIBOR) and the Tokyo Interbank Offered Rate (TIBOR), has thrown a spotlight on the shortcomings of benchmarks used in financial instruments and contracts.

Aimed at putting the regulation of benchmark-related administration, contribution and usage on a more exacting footing, the BMR will hopefully restore trust in benchmarks by introducing EU-wide rules.

What will the BMR do?

The BMR will apply more ‘assurance’ to benchmarks that asset managers use as financial instruments. The regulation seeks to improve things in three vital areas:

• governance and controls surrounding the benchmark process, especially in respect of conflicts of interest;
• the quality of input data and methods, with controls being placed over data contributors to stop them manipulating data or having conflicts of interest;
• protection for consumers and investors through a greater disclosure of information, through rights of redress and, in certain cases, through assessments of ‘suitability.’

'Suitablility' is a situation in which an investment strategy meets the objectives and means of an investor. The FCA’s Conduct of Business sourcebook (COBS) 9.2.1R requires a firm to take reasonable steps to ensure that a personal recommendation, or a decision to trade, is suitable for its customer. COBS 9.2.2R requires every firm, among other things, to take account of the customer’s risk profile and his preferences regarding the risks he wants to take and to ensure that he is able to bear any related risks regarding financial investments in a way that is consistent with his investment objectives.

Ultimately, the BMR will prohibit the use of benchmarks that no authorised administrator has provided, including those provided by unregistered administrators from so-called ‘third countries’.

Whom will it affect?

The BMR mentions three types of supervised entity.

• Administrator – an organisation that provides indices to benchmark users that they use when pricing or allocating assets to determine the amount payable to satisfy financial instruments, investments or contracts.
• Contributor – an organisation that contributes or provides input data to a benchmark used in the EU.
• User – a supervised entity that uses indices as benchmarks for financial instruments or contracts.

How will the BMR affect asset managers?

Each type of supervised entity has its own set of obligations under the BMR. The first thing that each European asset management firm should do is to find out how the regulation classifies it and to list its obligations.

As users of benchmarks, most asset managers will be obliged to do two things.

1. Ensure that the benchmarks they use in the EU are provided by administrators legally authorised or registered in the EU as benchmark administrators, or ensure that their use of “third-country benchmarks” (benchmarks from countries outside the EU) complies with the “equivalence requirements” (requirements to ensure that this-or-that country has benchmark laws up to the same standards as the EU) of the BMR.

2. Have robust contingency plans in place to be able to substitute the benchmarks they use, in case those benchmarks change ‘materially’ or cease to be published (in this respect, an understanding of the ways in which the BMR classifies benchmarks will be important: see box).

Benchmarks in detail

The BMR classifies benchmarks in three ways.

• Critical – used as references or measures for instruments, contracts or investments worth at least 500bn
• Significant – used as references or measures for instruments, contracts or investments worth at least €50 billion (£46 billion).
• Non-significant – used as references or measures for instruments, contracts or investments worth less than €50 billion.

The BMR affects the ‘critical’ and ‘significant’ benchmarks the most. It is possible that many of these benchmarks will be removed from the market and alternatives put in place. The disruption that this entails will affect all asset managers and it is therefore vital for them to have good benchmark data management systems in place.

Contributors are to be obliged to establish structures that ensure that input data is not affected by conflicts of interest and, when discretion is required, it is independently and honestly exercised.

The obligations that the BMR imposes on administrators are far-reaching and include the following.

• They must ensure that this-or-that benchmark is not affected by any conflict of interest and that discretion, if it is required, is exercised independently and honestly.
• They must have clear organisational structures with properly delineated and ‘consistent’ jobs for everyone involved in the provision of a benchmark.
• Each of them must establish a permanent function to review the benchmark’s ‘definition’ annually and oversee all controls and any involvement of ‘third parties’ in the process.

Some asset managers may find themselves classified as benchmark administrators if they use blended or bespoke benchmarks and will therefore have to comply with these administrative demands.

Act before it’s too late!

The BMR will require European asset management firms to overhaul their data management and compliance processes for benchmarks. Each one, as a first step, ought to draw up an inventory of the benchmarks it uses to help it understand their exposure to the risks that the EU wants it to offset. RIMES has produced a detailed white paper on the BMR, which provides more information on the regulation and what it means for asset managers.