14 November 2012

ESRB: Macro-prudential aspects of the reform of benchmark indices

The ESRB responded to the European Commission's consultation on the regulation of indices with a particular focus on the macro-prudential aspects of the reform of benchmark indices.

The General Board's discussions focused on how to rebuild confidence in the integrity of such instruments, on whether, in the future, reference benchmarks should better reflect changes in bank funding structures, and on how to ensure a smooth transition should regulatory reforms be initiated. 

The members of the ESRB, acknowledging the global dimension of the issue, look forward to the work of the relevant international institutions and fora, such as IOSCO and the BIS. In this context, the ESRB will put its views forward to the relevant authorities, also within the scope of the public consultation on the regulation of indices that was launched by the European Commission on 5 September, 2012.

Recent revelations of potential misconduct currently under investigation have highlighted that current systems are partly flawed. Shortcomings in calculation methods, the scope for manipulation, and the weakness of the governance of the process have become clear and have undermined confidence. To understand better the flaws and the options for reform that are being considered, the ESRB notes first that the sheer number of financial contracts impacted by the potential reform is tremendous. Indices of interbank interest rates, such as Libor and Euribor, are used as benchmarks for a range of financial contracts. Concerns have grown that benchmark interbank rates such as Libor and Euribor might not track interbank borrowing costs accurately.

Given the revealed manipulations, loss of credibility and identified weaknesses, there is a broad consensus that the systems ofLibor and Euribor need to be reviewed and structurally changed. The imperative of reform should also apply more generally to other indices used as references or benchmarks in financial contracts or financial instruments: those which are compiled from submissions such as some CDS and repo indices; those which are computed from actual transactions such as commodity price indices and asset price indices; and proprietary benchmarks, particularly those which are tailored to define payoffs from structured retail products, and which might entail conflicts of interest. Any legislation proposed by the Commission should clearly specify to which benchmarks the legislation refers.

Aside from ongoing investigations into (alleged) attempted manipulations, the ESRB recognises that several institutions have initiated work aimed at restoring credibility and upholding the integrity of market practices. The initiatives underway mainly focus on (i) potential remedies to address the specific shortcomings of reference benchmarks such as amending definitions, methodological changes, and strengthening the governance (e.g. the UK Wheatley Review into Libor), and (ii) evaluate potential alternatives. The ESRB also recognises that global regulators – in particular IOSCO but also FSB – are addressing the global dimensions of reform. In Europe, ESMA and EBA are working to develop principles or guidelines for reference rates and other benchmarks-setting processes. Given the international dimension of the issues at stake, the ESRB looks forward to the work of the relevant institutions and underscores the importance of their continued cooperation.

Full response

© ESRB - European Systemic Risk Board