A Quick Primer on Benchmark Regulation

What Is It?

The Benchmark Regulation (BMR) is a key part of the European Union’s (EU’s) response to the LIBOR scandal and the allegations of similar manipulation of foreign exchange and commodity benchmarks.  It is intended to protect investors by requiring greater transparency and stronger governance among firms that: 1) provide, 2) contribute to, or 3) use a wide range of interest rate, currency, securities, commodity, and other indices or reference prices.

Why Does It Matter?

The BMR is extensive in scope and impact because of the wide use of benchmarks throughout the EU.  Benchmarks are common reference values and performance measures for exchange-traded and conventional funds, structured notes, options, swaps, forwards, and other instruments.

Where and to Whom Does It Apply?

The BMR applies to the “use of a benchmark within the Union”[1] and to EU-based firms that are benchmark users, administrators, and contributors.  Further, the BMR applies to benchmarks used in the EU but provided by administrators located outside of the EU; S&P Dow Jones Indices would be such an example.

  • Users: In general, those that issue financial instruments (as defined in Section C of Annex I of MiFID2) or issuers of investment funds (UCITS/AIFs) tracking the return of an index or that use indices to determine the amount payable under an investment fund.
  • Administrators: Publishers of benchmarks and/or indices.
  • Contributors: Those supplying inputs necessary for the calculation of benchmarks and/or indices (other than regulated or other readily available data).

To be clear, the BMR does not place any requirements on those investing in financial products.  Rather, it is germane to those publishing, contributing to, or issuing financial products based on benchmarks.

When Is It Effective?

The BMR actually builds upon the Final Report of the Board of the International Organization of Securities Commissions (IOSCO) for Principles for Financial Benchmarks dated July 2013 (IOSCO Principles).  Since their introduction four years ago, S&P DJI has annually certified its adherence to those principles.  The BMR—which now creates formal legal requirements, as distinguished from the best practices or principles prescribed by IOSCO—will apply starting Jan. 1, 2018.[2]  There is a transition period[3] and the use obligations will be phased in.

How Does the BMR Affect S&P Dow Jones Indices?

As noted, even though we are a U.S.-based administrator, S&P Dow Jones Indices will fall under the BMR since our benchmarks are used within the EU.  This, despite the fact that the impetus for this framework (the aforementioned scandals) dealt with benchmarks far removed in nature, governance, and calculation from those calculated by S&P DJI.

An equivalence decision (that is, a decision by the EU Commission that a third country—e.g., the U.S.—has laws equivalent to the BMR) is unlikely.  We are therefore seeking to ensure the continued use of our indices in the EU through one of the two other available routes: recognition (meaning a national competent authority acknowledges that a third country administrator meets the requirements of the BMR by reference to its compliance with the IOSCO Principles) or endorsement (meaning a national competent authority acknowledges that an index provided by a third country administrator meets the requirements of the BMR by reference to its compliance with the IOSCO Principles).  Our team is working closely with EU policy makers and regulators and we expect to fully comply with the BMR framework.

In fact, we have long believed that publishers of indices and benchmarks must ensure a strict separation between commercial and benchmark calculation functions.  The potential for conflicts naturally arises when an organization publishes indices as well as prices components and/or issues investment products.

S&P DJI focuses on index publication and does not engage in investment banking, equity listing, investment management, or trading.  Similarly, we do not price index components or issue investment products; we source component prices from third parties, such as regulated exchanges, and we license our indices to third-party product issuers.  Such separation of index publication from other steps in the investment product development cycle ensures transparency, independence, and objectivity.

At S&P DJI, physical and organizational firewalls separate commercial and governance operations.  Final decisions about methodologies, index constituents, index rebalancing, etc. are all made within a distinct group with no relation to and restricted communications with commercial operations.  Changes in constituents and weights are governed by objective, rules-based, and publicly available methodologies found at https://www.spindices.com/.

Transparency is one of the most broadly accepted and valued tenets of index-based investing.  It is incumbent on all participants to ensure that benefit persists.

[1] Article 2.1 BMR

[2] Article 59 BMR

[3] Article 51 BMR

The posts on this blog are opinions, not advice. Please read our disclaimers.

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