As the FT reported yesterday, there is a regulation in the pipeline in which the Commission proposes significantly stepping up the regulation of benchmark indexes and rates used in financial markets and contracts. In particular though, it proposes moving the supervision of key benchmarks, such as Libor, to the European Securities and Markets Authority (ESMA).
As we did consistently throughout the FTT debate, we have got our hand on, and have exclusively published these latest plans – see here.
What are the key points of the plans?
- The main focus of the regulation is to move the oversight of thousands of benchmarks used in trillions of dollars’ worth of financial contracts and instruments away from self-regulation (or from being unregulated) to being under direct supervision.
- However, importantly, the proposal sees the most important benchmarks, such as Libor and Euribor, being supervised by ESMA since, in the Commission’s view, fractured oversight harms the single market.
- The plan also looks to step up the legal liability involved in the benchmarks (making any manipulation a criminal offence across the board) but also allowing supervisors more control to compel participation in certain benchmarks and allow for consistent oversight.
- First, let’s make it clear that Libor has patently failed and needs to be reworked. Everyone accepts that. However, the UK is currently in the midst of doing just this, following the recommendations of the Wheatley Review earlier this year (which happen to line up closely with those of IOSCO the international body looking into this issue).
- This makes the proposal particularly badly timed. It is ultimately based on an outdated view of Libor which is already under review and beign changed. In fact, if you look at the substance of the UK review and the international recommendations (upon which the Commission based its proposals) they line up fairly closely with the EU plans other than where the control rests.
- The Commission justification for needing an EU regulation on this issue also seems a bit of a stretch to us. Sure, some of these benchmarks are used in the rest of Europe but they are also used all over the world. However, all those involved in Libor will have a presence in London. As is well known, the large majority of European trades which involve many of these benchmarks will also take place in London. Why the oversight should not be focused there is still not clear.
- There is also rightly a significant concern over the rigidity of the Commission proposal. Firstly, the plan to base all submissions off actual transactions seems unrealistic. This issue came up in the initial debate about reworking Libor – ultimately, there are not nearly enough interbank transactions to actually produce the rates for the ten currencies and the 15 different maturities which Libor currently covers.
- Linked to the above point is the concern about the ability to force banks to comply and take on significant legal and regulatory responsibility for their submissions. Ultimately this is a large liability to take on off the back of what is still an estimate.
- This is a very technical subject. It is almost impossible to lay down all the rules and structures for how various benchmarks should be judged. Surely, the approach varies wildly depending on the benchmark and may even change depending on the wider economic and financial circumstance. This raises two concerns: the rigid framework presented may leave substantial grey areas but more importantly a lot of power for setting the technical details will be left up to the Commission, after the political negotiations have finished. As we saw with the bankers bonus’ regulation this can has a very large impact on the scope and practical implementation of the rules.
- It sets a worrying precedent, especially as the ECB is set to take over as the single eurozone supervisor and the potential for eurozone caucusing on this issue increases. As we saw with the regulation over Credit Rating Agencies (CRAs) over the last few years this can be dangerous. The initial drafts of the CRA regulations are quite similar to this one, however, worryingly it has extended and escalated over time. The UK government should look to tackle this issue head on to avoid a similar scenario.
Thankfully, it seems we are not the only ones with these concerns and some watering down of these rules already looks likely.