EU Benchmarks Regulation:Key issues and solutions for global indices February 2020

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Key questions and practical solutionsThe EU Benchmarks Regulation was created due to concerns about the accuracy and integrity of indices used as benchmarks in financial markets, following the LIBOR scandal. The Regulation implements and builds upon the global standards set out in the IOSCO Principles for Financial Benchmarks, which were published in July 2013.

The Regulation has implications for those who provide, contribute input data to, and reference, benchmarks within scope.

Timeline to date

30 JUNE 2016 EU Benchmarks Regulation came into force, though only certain provisions relating to critical benchmarks took effect

1 JANUARY 2018All other provisions of the EU Benchmarks Regulation took effect (subject to transitional arrangements)

1 JANUARY 2020EU administrators required to be authorised/registered with a National Competent Authority of a Member State

2016 20202018

1 JANUARY 2022EU users prohibited from new use of existing non-EU indices and use of new non-EU indices (pending equivalence, endorsement, or recognition)

1 JANUARY 2022ESMA to take over the supervision of non-EU benchmarks (from Member State National Competent Authorities)

2022

1 JANUARY 2023Under UK Brexit onshoring measures, UK users will be able to access non-UK indices for a further year (pending equivalence, endorsement, or recognition)

2023

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When will an index be in scope of the EU Benchmarks Regulation?The definition of “benchmark” for the purposes of the Regulation is extremely broad:

Any index by reference to which the amount payable under a financial instrument or a financial contract, or the value of a financial instrument, is determined, or an index that is used to measure the performance of an investment fund.

For index providers located outside the EU, their indices may fall within scope in the following circumstances:

Financial instruments When the amount payable under, or the value of, a financial instrument is determined by reference to the non-EU index.

Financial instruments, in this context, means those within scope of MiFID II (transferrable securities), in relation to which a request for admission to trading has been made, or which is traded on a EU trading venue or EU Systematic Internaliser.

A systematic internaliser is an investment firm which, on an organised, frequent, systematic, and substantial basis, deals on own account by executing client orders outside a regulated market, an MTF, or an OTF without operating a multilateral system.

Note: Many of the largest EU investment firms have opted in to systematic internaliser status and, therefore, trading of certain financial instruments that otherwise appear not to be trading on a formal EU venue may nevertheless be deemed in scope of the EU Benchmarks Regulation to the extent they are referencing benchmarks to determine any amount payable under, or the value of, the instrument.

Financial contract Where the amount payable under an EU consumer credit agreement or EU residential mortgage agreement is determined by reference to the non-EU index. (A less likely outcome given EU consumer protection laws).

Investment funds Where the non-EU index is used to measure the performance of certain investment funds (AIFs or UCITS), with the purpose of tracking the return, defining the asset allocation of a portfolio, or computing performance fees.

Note: Typically, the location of the manager is the key trigger for EU Benchmarks Regulation scope in this context, since that is the entity “using” the benchmark within the meaning of the regulation. Therefore, it would be possible to have a non-EU fund, with non-EU investors, managed by an EU manager, and fall within scope of the regime.

Index An index is any figure that is regularly determined on the basis of a calculation or assessment on the basis of the value of one or more underlying assets or prices, that is published or made available to the public.

Exemptions The EU Benchmarks Regulation does not apply to:

• Single reference price indices;

• Proprietary standard fixed or variable rates used by credit providers;

• Certain commodity indices based on submissions by mainly unregulated entities, trading on only one venue if the total notional value of financial instruments referencing the benchmark does not exceed €100 million;

• Central banks (e.g., base rates);

• Public authorities, if benchmarks are used for public policy purposes (inc. measures of employment, economic activity, and inflation);

• CCPs, if reference/settlement process is provided for CCP risk management purposes.

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How would I know if my indices are being used in the EU?There is currently no entirely conclusive method of determining whether non-EU indices are being used in the EU in a way that would fall within the scope of the EU Benchmarks Regulation. For non-EU index providers that only provide access to their indices under a licensed model, it is clearly easier to control EU distributions. If this is not the case, non-EU index providers may consider taking certain prudent steps in order to try to limit falling within scope of the regime in light of the following considerations:

1. The EU Benchmarks Regulation specifically exempts: “an index provider in respect of an index provided by said provider where that index provider is unaware and could not reasonably have been aware that the index is used [in a way which falls within scope of EU Benchmarks Regulation]”.

2. EU-supervised users of indices, if such use falls within scope of the EU Benchmarks Regulation, have an obligation to use only benchmarks that comply with the EU Benchmarks Regulation. Therefore, such use should stop if the EU users are not able to confirm that a non-EU administrator has made arrangements to comply with the EU Benchmarks Regulation.

3. Many non-EU benchmark administrators are including public statements on their website and/or amending their index licence agreements to confirm their status under the EU Benchmarks Regulation.

4. Index levels that are not published or made available to the public do not fall within scope of the EU Benchmarks Regulation.

Notably, EU trading venues and systematic internalisers shall submit reference data for the relevant financial instruments to National Competent Authorities (NCAs), who will subsequently transmit the reference data to ESMA for publication on its website. This requires submission of details of any index that the instrument derives its payout amount or value from. It is therefore possible to search the ESMA FIRDS register to find out if an index is being used. That said, there is no guarantee that the information contained on the ESMA register is up to date and complete, so the register is not viewed as an entirely reliable source.

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If I identify EU use of my indices, what do I need to do, and by when?Option 1: Cease all (known) new use of benchmarks by EU users by 1 January 2022.

Option 2: A non-EU benchmark may qualify for use in the EU in one of three ways, all of which require compliance with standards equivalent to those in the EU Benchmarks Regulation:

1. The jurisdiction in which the non-EU administrator is located has been deemed equivalent by the European Commission and certain formality requirements have been complied with, pursuant to Article 30 EU Benchmarks Regulation;

2. The non-EU administrator has been recognised to provide benchmarks into the EU, pursuant to Article 32 EU Benchmarks Regulation; or

3. The non-EU administrator has been endorsed to provide benchmarks into the EU, pursuant to Article 33 EU Benchmarks Regulation.

EQUIVALENCESummary requirements Points to noteA third country may be deemed “equivalent” to the EU and, in such cases, index administrators in that country can continue to provide benchmarks into the EU post 1 January 2022. The following must be in place before an equivalence decision is taken:

• The European Commission must make a positive equivalence decision in respect of the third country (taking into account whether the legal framework ensures compliance with the IOSCO Principles).

• The administrator must be authorised or registered, and subject to supervision, in the third country.

• A cooperation agreement between ESMA and the relevant non-EU regulator must be operational.

As of the date of this briefing, the European Commission has declared both Australia and Singapore equivalent for the purposes of the EU Benchmarks Regulation. Therefore, administrators in those jurisdictions can continue to access EU markets in compliance with the benchmark regime, subject to their benchmark being listed on the ESMA register. Notably:

• Australia and Singapore can be distinguished from many other non-EU jurisdictions on the basis they have formally legislated a regime for the supervision and enforcement of benchmark-related activities. This expands on the IOSCO “guideline” and creates a uniform standard of compliance on which an equivalence assessment can be based. Both regimes took into account the provisions of the EU Benchmarks Regulation when drafting their own mandatory rules.

• Neither the Australian nor Singapore regime mirror the extensive scope of the EU Benchmarks Regulation. Instead, the mandatory rules are limited to “significant” (Australia) / “designated” (Singapore) benchmarks, which is analogous to the EU Benchmarks Regulation’s concept of “critical” benchmark.

• EU benchmark administrators do not need to obtain a licence for their benchmarks to be used in Australia or Singapore, unless a benchmark is designated as a significant (Australia) / designated (Singapore) benchmark by ASIC/MAS, or if a benchmark administrator voluntarily seeks to be licensed in Australia. ASIC informed the Commission that it has no intention to designate EU benchmarks as significant.

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RECOGNITION• A non-EU administrator seeking recognition of its indices in the EU must submit an application to the relevant

EU Member State NCA in its Member State of Reference (which is determined by reference to the location of its designated “legal representative”).

• The identity of the legal representative is mandated by the EU Benchmarks Regulation. For global groups with a presence in the EU, this is determined by reference to a waterfall assessment set out in Annex B. Determining the legal representative is a key consideration for a non-EU administrator, because the legal representative assumes a degree of legal and regulatory risk and must have a role in the administrator’s oversight framework. The EU Benchmarks Regulation requires the legal representative to:

o Act on behalf of the administrator vis-à-vis the authorities and any other person in the EU with regard to the administrator’s obligations under the EU Benchmarks Regulation

o Perform the oversight function relating to the provision of benchmarks performed by the administrator under the EU Benchmarks Regulation together with the administrator

o Be accountable in relation to the oversight function to the NCA of the Member State of Reference (or ESMA from 1 January 2022)

• A non-EU firm must submit an application to be approved as a recognised non-EU administrator. This includes provision of comprehensive information about the non-EU firm, its benchmark compliance framework, and its relationship with the legal representative to the relevant EU Member State NCA.

• The non-EU firm must also provide and update a benchmark list for ESMA to publish on its register.

• Once a non-EU administrator is recognised, it can provide any new indices into the EU without further approvals.

• ESMA believes that the legal representative should have an organisational structure that is adequate in respect of: (i) the functions the representative has to perform; (ii) the characteristics and the dimension of the administrator it represents; and (iii) the number and significance of the benchmarks that the administrator provides and that are allowed for use in the EU.

• Under the current review of the EU Benchmarks Regulation, ESMA has suggested that the role of the legal representative, including its responsibilities and legal liabilities, should be clarified.

ENDORSEMENT• A non-EU benchmark can be endorsed by an EU NCA, at the request of an EU administrator who is authorised

or registered as an administrator under the EU Benchmarks Regulation (the Endorser).

• Separate applications for endorsement are required for each new benchmark (or family of benchmarks) intended for use in the EU.

• The Endorser must have the necessary expertise to monitor the benchmark effectively and manage the associated risks.

• There must be an objective reason for the provision of the benchmark in a third country, and for its use in the EU. See Annex C.

• It is important to note that:

o The Endorser remains fully responsible for the benchmark or family of benchmarks and for compliance with the obligations under the EU Benchmarks Regulation.

o There are no rules in relation to how a non-EU administrator must identify an Endorser (for example, there are no rules similar to those for identifying the legal representative under the recognition route), and therefore the non-EU administrator has more flexibility to choose an Endorser that is willing to assume this role and expand its own legal and regulatory responsibilities.

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A comparison of the recognition and endorsement routesPlease see Annex A to this note, which sets out the key consequences of following the recognition or endorsement route. A summary of this comparative analysis is set out below:

RECOGNITION ENDORSEMENT1. Regulatory accountability:

a. Non-EU administrator is directly accountable to ESMA for a regulatory breach of EU Benchmarks Regulation equivalent standards. A potential sanction for breach of EU Benchmarks Regulation equivalent standards is likely to be removal from the ESMA register and a prohibition on the use of the administrator’s indices in the EU.

b. Legal representative is accountable to the NCA in the Member State of reference for performing its role as legal representative.

2. Launch of new indices: No requirement to seek approval for each new benchmark (or family) launched.

3. Commercial: EU users gain comfort from knowing a non-EU administrator is approved by ESMA and compliant with EU-equivalent standards.

1. Regulatory accountability:

a. Non-EU administrator has no direct accountability to any EU regulatory authorities (such accountability sits with the EU Endorser).

b. The Endorser is responsible for breaches of EU Benchmarks Regulation equivalent standards by the non-EU administrator.

2. Launch of new indices: Each new benchmark will necessitate the Endorser submitting a new approval to the relevant EU NCA and a potential 90-day lead time for such approval to be granted. However, obtaining a single approval at benchmark family level to mitigate this submission is possible.

3. Reliance: In the event of a regulatory failing by the Endorser (which might result in a revocation or suspension of its licence), the non-EU administrator would have to cease the provision of indices to EU users.

4. Objective reason: There is a requirement to establish an “objective reason” for the provision of the benchmark in the EU. Member State NCAs have yet to confirm how this will be interpreted in practice, and market practice in this area will continue to evolve for some time.

5. Legal Risk (Endorser): The legal risk liability profile is increased for the Endorser under the endorsement model, as the Endorser takes full responsibility for compliance with EU Benchmarks Regulation standards by the non-EU administrator, and a user may sue the Endorser for breach of its regulatory obligations.

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What is the ongoing compliance burden of continuing to allow EU users to access a non-EU index?Non-EU index providers looking to follow one of the recognition or endorsement routes will need to look at their existing IOSCO compliance frameworks and consider the extent to which the framework provides EU Benchmarks Regulation equivalent standards. This will involve some dialogue with the relevant EU NCA to understand their expectation in this regard.

Certain elements of EU Benchmarks Regulation compliance may be important to EU users to assist with compliance with their own regulatory obligations, which could be an important commercial point when granting licences to EU users.

What level of EU third-party oversight needs to be exercised under the recognition/endorsement models?The diagram below provides an example of the type of information that needs to flow from the non-EU administrator to the EU entity (legal representative/Endorser), in order to demonstrate appropriate oversight. In the case of group entities, appropriate oversight could equally be achieved by a non-EU affiliate reporting to a global oversight committee of which the EU administrator forms a part. The diagram is high-level and is intended as a guide, and much of the detail on the content and frequency of reporting will be determined after an assessment of the indices themselves.

Benchmark inception

Annual review

Breach of Contributor

Code of Conduct

ComplaintChange to methodology

Restatement required Termination

Approval of new benchmark

launches

Data on whether

methodology is reflective of the benchmark

aims

Notice of breaches and overseeing of

remedial action

Data on complaints; considers individual

complaints where

appropriate

Data on changes to

methodology, processes and

challenges adopted

Data on restatements

Termination of EU availability approved by EU oversight

committee who also oversees

process (e.g., market consultation)

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Plan for establishing an appropriate oversight framework over a non-EU administratorSTEP 1: EU administrator to due-diligence existing IOSCO compliance framework of non-EU administrator to identify any material gaps with EU Benchmarks Regulation standards:

• EU administrator is required to verify that the non-EU administrator is compliant with standards “equivalent to EU Benchmarks Regulation”.

• Due diligence may be conducted by way of review of audit reports or review of policies/procedures.

STEP 2: EU administrator and non-EU administrator to agree on level of oversight reporting from non-EU oversight committee to EU administrator oversight committee, which should be embedded within a service level agreement between the two entities:

• Some firms consider appointing a member of the EU administrator to attend meetings (in a non-voting capacity) of the non-EU oversight committee, whereas other firms agree to the provision of information to the EU administrator’s oversight committee.

• EU administrator and non-EU administrator agree information to be reported by the EU administrator to the non-EU administrator on the EU firm’s own regulatory compliance with the EU Benchmarks Regulation, in particular, any change in law, regulatory action, or investigation that could threaten the ability of the EU administrator to provide inbound services.

Recognition modelESMA has issued specific guidance for legal representatives under the recognition model:• In order to be able to perform the oversight function, together with the administrator, for benchmarks used or

allowed for use in the EU, the legal representative should, at least, be a member of the oversight function.

• The oversight function shall assess, and when appropriate, challenge, the decisions of the management body of the administrator with regard to the provision of benchmarks to ensure the fulfilment of the requirements of the EU Benchmarks Regulation. Therefore, the legal representative should be able to ask and obtain from the administrator all the necessary information in this respect. ESMA considers that a possible way to achieve this measure is for the legal representative to have agreements in place with the administrator.

• The oversight function must report to the relevant NCA any misconduct by administrators, of which the oversight function becomes aware. The legal representative should be able to inform the relevant NCA in the event that it finds that the non-EU administrator does not comply with the relevant legal requirements.

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The ESMA register: What information is publicly available? ESMA maintains a register that contains information on:1. EU-authorised or EU-registered administrators2. Benchmarks and the administrators that provide those benchmarks by virtue of a positive decision under either

the equivalence regime or the recognition regime3. EU administrators or supervised entities that have endorsed benchmarks from a third country, and on any such

endorsed benchmarks and their administrators located in a third country

Which regulatory body will supervise non-EU benchmark administrators?At present, the relevant NCA for the purposes of a non-EU index provider accessing the EU is the NCA located in the Member State of the Endorser (endorsement model) or legal representative (recognition model).From 1 January 2022, ESMA will become the competent supervisory authority for non-EU administrators of benchmarks that are used in the EU. ESMA will be granted the power to recognise and approve the endorsements of non-EU administrators and benchmarks. This will effectively move to a centralised EU supervisory model for non-EU benchmark administrators.The effect of ESMA assuming this role will be:• Non-EU administrators must be recognised by ESMA (rather than by NCAs)• The legal representative will be accountable to ESMA in relation to its oversight role (see below) (rather than to

any particular NCA)• Non-EU administrators must apply to ESMA (rather than making applications to NCAs)It is difficult to see how ESMA might become accustomed to recognising a non-EU administrator, if ESMA is not able to evidence an EU legal representative that can effectively supervise the non-EU firm in relation to benchmark activities. This calls into question the use of the recognition route for firms with legal representatives that are not EU authorised benchmark administrators.The transference of supervisory measures and investigatory powers (including the ability to impose sanctions, which include fines) for infringements of the EU Benchmarks Regulation from NCAs to ESMA is a key watch point for non-EU administrators.

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ANNEX AComparative analysis of recognition and endorsement

AREA RECOGNITION ENDORSEMENT KEY DIFFERENTIATOR(S)1 Application

process• Non-EU administrator applies

to EU Member State NCA for recognised status.

• EU Member State NCA confirms to ESMA whether significant/non-significant benchmarks are administered by non-EU firm.

• ESMA issues advice to NCA about the type of benchmark and the requirements applicable to its provision.

• NCA notifies ESMA of any decision to recognise a non- EU administrator and provides list of benchmarks provided by the administrator, which may be used in the EU.

• Authorised/registered EU administrator applies to EU Member State NCA to endorse a benchmark or family of benchmarks provided by a non-EU administrator, for use in the EU.

• NCA approves endorsement (without sign-off from ESMA).

• NCA notifies ESMA of benchmarks or families of benchmarks endorsed for use in EU.

• Recognition- Application owned and

submitted by non-EU administrator.

- One application and no further restrictions on the number/frequency of benchmarks provided into the EU by the non-EU administrator.

- Non-EU administrator sits on the ESMA register (EU users searching the index will take comfort from the fact that the non-EU administrator has been approved by ESMA).

• Endorsement- Individual benchmarks/

families approved for use.- Application process is

owned and submitted by the EU benchmark administrator.

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AREA RECOGNITION ENDORSEMENT KEY DIFFERENTIATOR(S)2 EU Benchmarks

Regulation-compliant framework required?

• Non-EU administrator should demonstrate IOSCO compliance that is “at least equivalent” to the provisions under the EU Benchmarks Regulation other than Article 14(4) (changes to input data if it does not reflect a particular market or economic reality) and certain rules in relation to critical benchmarks.1

• The Endorser should be able to demonstrate that the non- EU administrator is compliant with standards “at least as stringent” as the relevant EU Benchmarks Regulation provisions.2 Notwithstanding that the EU Benchmarks Regulation allows for IOSCO compliance to be taken into account, having a globally consistent framework around benchmark compliance would better manage the regulatory risk for the Endorser since it would mitigate need for that entity and its overseas affiliates to operate under and oversee two different regulatory regimes.

• In practice, we rarely see circumstances in which non-EU administrators have implemented IOSCO in a manner that is at least equivalent, or at least as stringent as (endorsement) the EU Benchmarks Regulation. Our view is that a non-EU administrator would be advised to uplift its existing IOSCO framework to EU Benchmarks Regulation standards, particularly as IOSCO likely will seek to close this gap over time.

• If an EU Benchmarks Regulation uplift is not achieved, then the regulatory risk profile of the various entities involved in each option is slightly different.

Consequence of non-EU administrator’s failure to comply with EU Benchmarks Regulation equivalent standards:

1 Article 32(2) EU Benchmarks Regulation.2 Article 33(1)(a) EU Benchmarks Regulation. When assessing whether the provision of the benchmark or family of benchmarks to be endorsed fulfils requirements

which are at least as stringent as the requirements of EU Benchmarks Regulation, the NCA may take into account whether the EU Benchmarks Regulation compliance of the provision of the benchmark or family of benchmarks with the IOSCO Principles For Financial Benchmarks, would be equivalent to compliance with the requirements of EU Benchmarks Regulation.

Legal rep (recognition)

Exposed to enforcement by EU NCA (assuming legal rep is a regulated entity)

Legal rep (endorsement)

N/A

Endorser (recognition)

N/A

Endorser (endorsement)

Exposed to enforcement by EU NCA

Non-EU administrator (recognition)

Exposed to removal from the ESMA registerCould impact terms of any user licence agreement where EU users rely on statements to the effect that the benchmark will be provided in accordance with applicable laws / by an administrator on the ESMA register

Non-EU administrator (endorsement)

N/A (non-EU administrator does not hold authorised status)Could impact terms of any user licence agreement under which EU users rely on statements to the effect that the benchmark will be provided in accordance with applicable laws / endorsed for use in the EU

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AREA RECOGNITION ENDORSEMENT KEY DIFFERENTIATOR(S)3 Application

requirements• Independent assessment of

IOSCO (or EU Benchmarks Regulation) compliance: by independent third party, OR, for supervised entities, certification by the home regulator.3

• Legal representative: in Member State of reference.4

• Existence of a cooperation agreement between the Member State of reference and the relevant non-EU regulator.

• There must be an objective reason for:- The provision of the

benchmark in the non-EU country

- Its use in the EU5

See Annex C for technical advice on objective reason.Note 1: Potential non-admission of the index would have some adverse effect on users in the Union.6

Note 2: Are objective reasons cumulative, or is one enough?7 Note 3: The indication of objective reason is strong if the index is likely to be used to a material extent in the EU and there no available substitutes in the EU.8

Note 4: Member State NCAs clearly have not yet defined their views on what would amount to an objective reason. However, the objective reason test also does not appear to be intending to set the bar so high so as to restrict access to non-EU benchmarks. We would also argue that the bar for satisfying the objective reason test might be set lower for non-significant benchmarks, such that fewer of the sample categories require clarification. Therefore, the only way for non-EU firms to get certainty on this point will be to seek the view of the relevant NCA.

• Recognition requires confirmation that the relevant non-EU regulator and the Member State of reference have a cooperation agreement in place, in addition to requiring independent sign-off that equivalent EU Benchmarks Regulation compliance exists.

• Endorsement sets a higher bar for application due to the need to establish an objective reason for the provision of the benchmark in the EU.

• Member State NCAs have yet to confirm how this will be interpreted and market practice in this area will continue to evolve for some time. However, in the short term, each benchmark/family will need to be assessed to determine whether the objective reason test is satisfied.

3 Article 32(2) EU Benchmarks Regulation. The FCA draft form for recognition confirms that either option is acceptable. We understand the Dutch AFM has copied these forms.

4 Being the EU country with the largest number of regulated entities or, in the case of groups with equal numbers of EU entities in a certain jurisdiction, the country where the value of financial instruments that reference the benchmark are highest – see Annex B.

5 ESMA Final Report 2016/1560 sets out guidance on what might amount to an ‘objective reason’ (pages 53 – 55).6 Firms should monitor market practice and further guidance from NCAs as to whether disadvantaging users in terms of choice and lack of competition alone would

amount to an ‘adverse effect’ for these purposes.7 ESMA Final Report 2016/1560: ‘ESMA remains of the view that the satisfaction of a single factor may not be sufficient to provide an objective reason for

endorsement. Nevertheless, it considers that the approach should be flexible, as indicated by CP and the draft technical advice itself. The competent authority should take the criteria, along with the supporting indicators, into account; but not each aspect needs necessarily to be satisfied in each case. The decision of the competent authority may depend on the strength and number of supporting indicating factors.’

8 ESMA Final Report 2016/1560: ‘It should be noted that in the evaluation of objective reason for endorsement of a 3rd country benchmark that is not already referenced in financial contracts/instruments and/or investment funds in the Union, the presence of market-led substitutes for such benchmark is a relevant element. The possibility for potential users in the Union to make recourse to a different and available benchmark can be an argument against the endorsement of a 3rd country benchmark. However, ESMA accepts the view that for a 3rd country benchmark which is already referenced in financial contracts/instruments and/or investment funds in the Union the presence of market-led substitutes is not an appropriate element of evaluation of an objective reason for endorsement as this could imply a suggestion to change the reference from one benchmark to another.’

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AREA RECOGNITION ENDORSEMENT KEY DIFFERENTIATOR(S)4 Application pack • Long-form application form:

- Completed by non-EU administrator

- Benchmark schedule form9

- Group structure chart- Governance structure chart

(board, senior management committees, oversight function)

- Governance committee terms of reference

- Detail of legal representative

- Detail of legal representative’s role in the oversight function relating to the provision of benchmarks10

- Procedures demonstrating competence of employees involved in benchmark administration

- Conflicts of interest mapping and control policies

- Remuneration policy for persons involved directly in the provision of benchmarks

- Policy & procedures – IT systems

- Policy & procedures – Risk management

- Policy & procedures – Oversight function

- Policy & procedures – Control framework

- Policy & procedures – Accountability framework

- Policy & procedures – Fallback systems

- Policy & procedures – Internal reporting of infringements

- Outsourcing arrangements (+ policies & procedures)

- Information on benchmarks including input data and methodologies (+ policies & procedures for benchmark administration + benchmark statements)

• Short-form application form:- Completed by Endorser- Benchmark schedule form9

- Complete a schedule of benchmarks to be endorsed

- Describe EU administrator’s role within the endorsing framework

- Outline objective reason

• Recognition: Has the benefit of being a one-off application (albeit a more involved application process). The process should be viewed as equivalent to the application being submitted by an EU benchmark administrator.

• Endorsement: Whilst short-form, the application is required to be repeated in the case of any new benchmark/ family.

9 ESMA Final Report 70-145-48 para 338: ‘for 3rd country administrator ESMA register will include not only the name of the administrator, but the list of their benchmarks that can be used in the Union by supervised entities (in the case of EU administrator, the register will include only the name of the administrator, not its benchmarks).’

10 Note: It may be prudent to consider the inclusion of an intra-group services agreement which confirms that the legal representative has authority over the applicant administrator

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AREA RECOGNITION ENDORSEMENT KEY DIFFERENTIATOR(S)5 Approval/

registration (pre 1 January 2022)

• Requires approval from NCA in Member State of reference.

• Requires approval from NCA in which Endorser is located.

N/A

6 Timing (approval) (pre 1 January 2022)

• NCA has 90 days to review, subject to right of ESMA to delay.

Note: It is expected that the 90- day period will be used in full, especially taking into account any questions the NCA might have.

• NCA has 90 days to review, with no right of ESMA to delay.

Note: We assume that once a non-EU administrator’s indices have been endorsed for the first time, subsequent additions of new indices to endorsed families will be relatively process-driven and should only take a few days. However, the NCA has every right to use the full 90 days.

A key downside of the endorsement route is the uncertainty around the ability to get new indices added to endorsed families and approved in line with the commercial time pressures of the relevant business.

7 Deadline • Application before 1 January 2022.

• Application before 1 January 2022.

N/A

8 Index owner Non-EU firmIndices can be licensed to users and monetised by the non-EU firm.

Non-EU firmIndices can be licensed to users and monetised by the non-EU firm.

N/A

9 Administrator Non-EU firmFrom an EU user perspective, the non-EU firm will be identified on the ESMA register, which will assist the EU user in seeking comfort that it can comply with its own regulatory obligations by knowing it is using an administrator approved by ESMA.

Non-EU firm, however, the Endorser is fully responsible for regulatory failings as if it were the administrator.It will be important to market the index to EU users as “Index Name, endorsed for use in the European Union by [insert EU administrator]”.

EU users may express a limited preference to use non-EU benchmarks if the administrator has been approved by ESMA, as under the recognition model.

10 Non-EU firm obligations

• Compliance with EU Benchmarks Regulation standards11

• Enhance IOSCO framework to close gaps against EU Benchmarks Regulation obligations.

• Governance reporting to EU legal representative.

• Update ESMA register with new benchmarks.

• Compliance with EU Benchmarks Regulation standards.

• Enhance IOSCO framework to close gaps against EU Benchmarks Regulation obligations.

• Governance reporting to EU administrator.

• Update ESMA register with new benchmarks.

Note: There is no regulatory certainty at this stage as to how European regulators will interpret the obligation to comply with IOSCO equivalent/stringent standards. In our view, from a purely technical perspective, an IOSCO framework is unlikely to comply with the EU Benchmarks Regulation requirements without some uplifts. However, it is conceivable that European regulators will want to take a pragmatic view on this point due to a general desire not to prejudice European users by restricting access to non-EU benchmarks.

11 Other than Articles 11(4) (changes to input data); 16 (supervised contributors); 20, 21 & 23 (rules for critical benchmarks).

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AREA RECOGNITION ENDORSEMENT KEY DIFFERENTIATOR(S)11 EU firm

obligations• Act on behalf of the non-EU

administrator vis-à-vis the authorities and any other EU person with regard to the non- EU administrator’s obligations under the EU Benchmarks Regulation.

• Oversight function: Perform the oversight function together with the non-EU administrator.

• Verify compliance by the non-EU administrator with standards equivalent to the EU Benchmarks Regulation (taking into account IOSCO compliance).

• Have “necessary expertise” to monitor the non-EU benchmark effectively and manage associated risks.

• Have a clear and well-defined role within the accountability framework of the non-EU administrator.

• Recognition: May be a better option if the indices administered by a non-EU administrator are substantially different to those falling within the existing expertise of the Endorser.

• Endorsement: It will be necessary for the Endorser to demonstrate the necessary expertise to monitor the administration of the non- EU indices. Our assumption is that there will be a requirement to demonstrate a certain amount of subject matter expertise. Therefore, endorsement is a useful model if the non-EU indices are similar to those administered, and falling within the expertise of, the Endorser.

In practice, under both models, we see the governance structure operating such that the non- EU administrator retains its existing governance structure and oversight committee, and that oversight committee reports into the oversight committee of the EU administrator OR alternatively, a member of the EU oversight committee might also sit on the non-EU administrator’s oversight committee.

12 Legal risk (vis-à-vis) EU users

• EU users could sue non-EU administrators under contract/ licence.

• EU users could potentially also sue a regulated legal representative for failing to comply with its own regulatory obligations to oversee a non- EU administrator.

• EU users could sue non-EU administrators under contract/ licence.

• EU users could potentially also sue EU administrator for failing to comply with both its own regulatory obligations and failings by the administrator.

• Recognition: The legal risk liability profile of the Endorser is limited to exercising adequate oversight over the non-EU administrator.

• Endorsement: The legal risk liability profile is increased for the Endorser under the endorsement model since is takes full responsibility for compliance with EU Benchmarks Regulation standards by the non-EU administrator.

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AREA RECOGNITION ENDORSEMENT KEY DIFFERENTIATOR(S)13 Scope of

regulatory oversight

Note: We are not aware that any EU regulator has yet set out the scope of regulatory oversight it would expect to exercise over a non-EU administrator. However, we expect the relevant regulator’s examination of the non-EU administrator and its indices to focus primarily at the application stage.Oversight is likely to be channeled via a supervised legal representative in terms of reviewing its arrangement for the oversight of the non-EU administrator. Any failings on the part of the EU administrator in this regard are likely to result in action against the EU administrator by the relevant NCA.

Note 1: We are not aware that any EU NCA has yet set out the scope of regulatory oversight it would expect to exercise over a non-EU administrator. Note 2: We would not expect an EU administrator endorsing its affiliate’s benchmarks to seek indemnification. However, we anticipate indemnification being possible where the non- EU administrator seeks an EU independent administrator to endorse its benchmarks. Note 3: We are not aware of an EU NCA that has yet confirmed its position on interpreting the objective reason obligation but we expect that they will assess individual indices in light of their own views on this test.

• Recognition: In theory, the ability of the non-EU administrator is not dependent on its legal representative remaining licensed. Although this is subject to the local preferences of the relevant NCA.

• Endorsement: A key factor in the ability of the non- EU administrator to enjoy continued access to EU users is dependent on the EU entity retaining its licence to act as an EU benchmark administrator.

14 Regulatory risk (EU Benchmarks Regulation)

EU administrator is “accountable” to the EU Member State NCA for failing to perform the oversight function relating to the provision of benchmarks performed by the administrator. Non-EU administrator is accountable to ESMA for EU Benchmarks Regulation equivalence compliance.

EU administrator “fully responsible” for EU Benchmarks Regulation compliance.Non-EU administrator has no accountability to any EU authorities since it is not directly regulated in the EU.

• Recognition: The EU Benchmarks Regulation regulatory risk liability profile of the legal representative is limited to exercising adequate oversight over the non-EU administrator. This is because the regulatory risk sits with the non-EU administrator.

• Endorsement: The EU Benchmarks Regulation regulatory risk liability profile is increased for the Endorser under the endorsement model, since it takes full responsibility for compliance with EU Benchmarks Regulation standards by the non-EU administrator. Consequently, the third-party administrator has no regulatory risk.

15 Regulatory risk (IOSCO)

Sits with non-EU administrator. Sits with non-EU administrator. N/A

16 Product documentation

Non-EU administrator listed as “administrator” of indexDocumentation would also list legal representative for use in the EU.

Non-EU administrator listed as “administrator” of indexDocumentation would confirm the index was “endorsed” for use in the EU by the EU administrator.

N/A

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AREA RECOGNITION ENDORSEMENT KEY DIFFERENTIATOR(S)17 Entity to entity

documentation• “Express” appointment of legal

representative required.• Mandate of legal

representative’s oversight function to include non-EU administrator.

• Endorser to be able to require changes to the non-EU administrator’s policies and procedures to ensure EU Benchmarks Regulation compliance.

• Endorser’s accountability framework to capture non-EU firm.

• Endorser likely to require sight of all documentation that the non-EU administrator’s oversight function receives.

• Endorser must have a clear and well defined role within the control and accountability framework of the non-EU administrator.

• Endorser must also report on its compliance with the EU Benchmarks Regulation to the non-EU administrator.

ANNEX BArticle 32(4) EU Benchmarks Regulation – Determination of the Member State of ReferenceThe Member State of reference of an administrator located in a non-EU country shall be determined as follows:

a) where an administrator is part of a group that contains one supervised entity located in the Union, the Member State of reference shall be the Member State where that supervised entity is located. Such supervised entity shall be appointed as the legal representative for the purposes of paragraph 3;

b) if point (a) does not apply, where an administrator is part of a group that contains more than one supervised entity located in the Union, the Member State of reference shall be the Member State where the highest number of supervised entities are located or, in the event that there is an equal number of supervised entities, the Member State of reference shall be the one where the value of financial instruments, financial contracts or investment funds that reference the benchmark is highest. One of the supervised entities located in the Member State of reference determined pursuant to this point shall be appointed as the legal representative for the purposes of paragraph 3;

c) if neither point (a) nor (b) of this paragraph applies, where one or more benchmarks provided by the administrator are used as a reference for financial instruments admitted to trading in a trading venue as defined in point (24) of Article 4(1) of Directive 2014/65/EU in one or more Member States, the Member State of reference shall be the Member State where the financial instrument referencing any of those benchmarks was admitted to trading or traded on a trading venue for the first time and is still traded. If the relevant financial instruments were admitted to trading or traded for the first time simultaneously on trading venues in different Member States, and are still traded, the Member State of reference shall be the one where the value of financial instruments, financial contracts or investment funds that reference the benchmark is highest;

d) if points (a), (b) and (c) do not apply, where one or more benchmarks provided by the administrator are used by supervised entities in more than one Member State, the Member State of reference shall be the Member State where The highest number of such supervised entities are located or, in the event that there is an equal number of supervised entities, the Member State of reference shall be the one where the value of financial instruments, financial contracts or investment funds that reference the benchmark is highest; and

e) if points (a), (b), (c) and (d) do not apply and if the administrator enters into an agreement consenting to the use of a benchmark it provides with a supervised entity, the Member State of reference shall be the Member State where such supervised entity is located.

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ANNEX CESMA Technical Advice (2016/1560): Endorsement “Objective Reason” Measures to determine the conditions on which the relevant competent authorities may assess whether there is objective reason for the provision of a benchmark or family of benchmarks in a non-EU country and their endorsement for their use in the Union

When considering an application for endorsement of a non-EU country benchmark or family of benchmarks, the competent authority of the administrator or other supervised entity should take into account the following non-exhaustive list of criteria:

1. Objective reasons for the provision of a benchmark or family of benchmarks in a non-EU country

(a) Geographical proximity

An indicator for an objective reason for the provision of the benchmark in a non-EU region can be the occurrence of one or more of the following circumstances:

(i) the market it is intended to measure is geographically limited to a certain region and the benchmark provider is closely linked to that market;

(ii) where the benchmark is based on contributions, the contributors are all, or in majority, located in the same non- EU region of the provider; or

(iii) the non-EU country provider can access the infrastructure available in the non-EU region exclusively or can maintain systems necessary for administering the benchmark only locally

The indication is strong if the applicant Endorser can demonstrate that:

(i) the benchmark may not be provided by an administrator in the Union including for technical reasons or the non-EU country legal framework or, in exceptional cases, a different time zone; or

(ii) providing the benchmark geographically near the market it is intended to measure leads to reduction of costs, or avoidance of a material increase in costs which would have likely resulted from a transition into the Union of the benchmark provision, and that this is directly and significantly advantageous to end-investors or consumers in the Union.

(b) Specific skills required in the benchmark provision

An indicator for an objective reason for the provision of the benchmark in a non-EU region can be that the benchmark relies partly on expertise of individuals/firms located in a non-EU country and this expertise is based on individual experience and/or personal skills that are associated with employees of the non-EU country benchmark provider or non-EU country contributors.

The indication is strong if the applicant Endorser can demonstrate that:

(i) the relevant personnel within the non-EU country provider or, more generally, the non-EU country provider itself is prevented from providing its expertise to an entity in the Union, as a result of the non-EU country legal framework; or

(ii) relying on the individual experience and/or personal skills of the employees of the non-EU country benchmark provider for the provision of the benchmark leads to reduction of costs, or avoidance of a material increase in costs which would have likely resulted from a transition into the Union of the benchmark provision, and that this is directly and significantly advantageous to end-investors or consumers in the Union.

(c) Legal or other restraints to obtain input data

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ANNEX C (continued)An indicator for an objective reason for the provision of the benchmark in a non-EU region can be that the benchmark is based on non-EU country input data and the necessary data cannot be submitted to an administrator in the Union to be processed for provision in the EU because of constraints as a result of the non-EU country legal framework.

(2) Objective reasons for the use of a non-EU country benchmark or family of non-EU country benchmarks in the Union

(a) Effects on benchmark users in the Union

An indicator for an objective reason for the use of a non-EU country benchmark in the Union can be that the non-endorsement of such benchmark would have adverse consequences in the Union.

The indication is strong if the applicant Endorser can demonstrate that:

(i) the benchmark is used to a material extent in the Union; and

(ii) the discontinuation of the use of the non-EU country benchmark would adversely and materially affect users of the benchmarks in the EU or adversely affect the financial stability or market integrity of the European area in which it is already used, or the consumers, the real economy or the financing of households and businesses in that area.

(b) Effects on potential benchmark users in the Union

An indicator for an objective reason for the use of a non-EU country benchmark in the Union can be that the nonendorsement of such benchmark could in the future adversely and materially affect the financial stability or market integrity of the European area, or the consumers, the real economy or the financing of households and businesses in that area.

The indication is strong if the applicant Endorser can demonstrate that:

(i) the benchmark is likely to be used to a material extent in the Union; or

(ii) there are no market-led substitutes available in the Union, for the non-EU country benchmark.

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Becky Critchley Associate T +44.20.7710.1000 E becky.critchley@lw.com

Douglas K. Yatter Partner T +1.212.906.1211 E douglas.yatter@lw.com

Courtenay Myers Lima Partner T +1.212.906.1691 E courtenay.myerslima@lw.com

Yvette D. Valdez Partner T +1.212.906.1797 E yvette.valdez@lw.com

Nicola Higgs Partner T +44.20.7710.1154 E nicola.higgs@lw.com

Rob Moulton Partner T +44.20.7710.4523 E rob.moulton@lw.com

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