27 November 2012

ICMA submits comments to European Commission consultation document on "The Regulation of Indices"

In overall terms, the ICMA considers that:

(i) the authorities' focus in reforming indices should be on regulating the governance of the process for setting indices to ensure that it cannot be manipulated and to prevent market abuse;

(ii) it is important that any reform of rate-setting processes for existing transactions referenced to indices does not disrupt the international capital market;

(iii) it is for the market to choose, as a commercial matter, which reference rates to use for new transactions;

(iv) if powers to compel participants in financial markets to make submissions to benchmarks exist, they should only be used as a last resort, and where there is a significant risk of widespread disruption to the international capital market; and

(v) any market abuse should be covered by appropriate market abuse regulation.

In ICMA's response, it focuses on (ii) and (iii), particularly commenting on the question of how changes to, or transition from, existing indices could affect certain types of financial contract. Before covering these points, the ICMA wishes to highlight the existence of other official initiatives concerning similar issues, including the work of the UK Government’s Wheatley Review and that within the central banking community. Inevitably there are elements of overlap amongst these initiatives and there is a risk, which needs to be managed, that the proposals which emerge may not necessarily all fit neatly together, either with respect to their content and/or their timing. Since the implications of any combination of actual proposed changes may differ (for a variety of reasons, including that outstanding index based contracts are governed by a variety of different laws), and cannot be assessed in advance of an actual change proposal, the ICMA respectfully requests that every effort be made to sustain ongoing dialogues – both between the requisite officials and with the markets. It is in everyone’s best interests that the issues are adequately addressed, whilst at the same time avoiding any unnecessary adverse implications for the international capital market. Given the international nature of the capital market it is desirable that there be an appropriate degree of consistency of approach between measures being adopted by different authorities.

The ICMA also notes that the Global Financial Markets Association (GFMA) is publishing an updated set of proposed “Principles for Financial Benchmarks” (refreshing the Principles document first published by the GFMA on 10 September). In this publication, “The Principles are grounded in three fundamental sponsor obligations, which should be applied in a manner commensurate with the significance of the benchmark”, namely Governance; Benchmark Methodology and Quality; and Controls. Furthermore, whilst the GFMA states that “The Principles are intended to apply broadly to benchmarks across asset classes and operating models”, it then goes on to highlight that “There are some exceptions to application of the Principles": In summary these are:

• Use – “indices that are primarily used for purposes other than pricing financial instruments or contracts are excluded from scope”;
• Scale – “customised indices used for pricing bespoke bilateral or similar transactions among a limited number of counterparties are excluded”; and
• Public Source – “indices issued by public sector entities are out of scope”.

Whilst these principles cover matters well beyond the limited scope of this ICMA response, the ICMA recognises that it would be highly valuable to achieve international recognition for a set of principles along these lines, which could contribute significantly to the achievement of an appropriate degree of consistency of approach. The ICMA also supports the concept that there should be appropriate limitations to the scope of application of official requirements for benchmarks and indices; and suggests that, in this regard, the GFMA’s proposals may represent a relevant, helpful starting point.

Under date of 7 September 2012, the ICMA made a response submission to “The Wheatley Review of LIBOR”, a copy of which is appended hereto. In this earlier response the ICMA provided detailed comments (A) addressing how changes to, or transition from, LIBOR could affect certain types of financial contract; (B) commenting on certain points pertaining to the consideration of alternatives to LIBOR; and (C) offering some brief observations regarding other existing benchmarks.

The ICMA believes that its comments regarding the potential implications of changes to LIBOR are of direct relevance to the European Commission’s question #39, regarding transition from a relevant benchmark. Beyond the specific case of LIBOR, these same earlier ICMA comments are illustrative of the sort of considerations which are broadly applicable when addressing any potential change to an established index. Accordingly the ICMA requests that the European Commission carefully review this earlier ICMA submission and, in taking forward its broader work on the regulation of indices, take full account of the concerns expressed therein.

The ICMA also highlights that the data analysis provided in its earlier response is pertinent to the European Commission’s question #5, regarding the value of financial instruments referenced to benchmarks. Furthermore, the commentary in section (B) of ICMA’s earlier response relates to the European Commission’s queries about the use of “real transactions” (in question #6) and the use of “actual data” (in question #9).

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