European Commission unveils new benchmark regulation

The European Commission has revealed its first draft for a new regulation on benchmarks, including those used in energy derivative contracts.

The Commission’s proposal, named the Regulation on Indices used as Benchmarks in Financial Instruments and Financial Contracts, comes in the wake of manipulation of inter-bank interest rates, as well as probes into how energy price reporting agencies assess the market.

The regulation will apply to administrator of benchmarks – including price reporting agencies like ICIS, Platts and Argus – as well as any source that give them information.

The International Organization of Securities Commissions (IOSCO) has already set out principles for benchmarks, which most price reporting agencies have signed up to, but the Commission still wants to legislate on an EU level to make sure companies follow the same rules across member states.

Data

The proposal sets out EU rules for data that is used for an index or price assessment that is then used in a financial contract.

In liquid markets, the Commission prefers that benchmarks are based on transaction data.

Benchmark administrators would be obliged to have a methodology for excluding trades and keep track of when a decision to exclude transactions is taken.

In markets where there are too few deals done on a given day to assess the price, other kinds of data could be used, as long as this data is “verifiable”.

Bids and offer are the second choice, followed by “other information”, with no more specific definition.

If a benchmark is not based on transactions and a single company provides more than 50% of the data used instead, it is up to the administrator to check this alternative data reflects a competitive market, and to adjust it if this is not the case.

This is a change from an earlier leaked draft, which stated that no company would be able to contribute more than 25% of the volume or value of the transactions used to set the benchmark.

All companies that provide this kind of data would have to sign a legally binding code of conduct with the price reporting agency.

Under this code of conduct, companies contributing for example transaction data would have to sign up to not excluding any deals and keep records of the information that they have sent to the price reporting agencies.

Methodology

The regulation also states that price reporting agencies have to use a “robust” methodology when they set the benchmarks and also show exactly how price reporters can use discretion when they apply this methodology.

Most reporting agencies, including ICIS, already have methodologies for pricing, but this has so far not been a legal requirement.

If a price reporting agency suspects that there is an attempt of market manipulation, it would have to flag this up to a regulator.

Next steps

The Commission said on Wednesday it expects to get approval from the EU’s decision-making bodies – the European Parliament and the Council – before the European Parliament elections next spring, with the rules then coming into force in 2015.

Much of the detail on when benchmarks could be based on something other than transactions – like bids and offers at a close – will emerge later, during so-called delegated acts. These kinds of acts let the Commission leave technical decisions to national governments and experts, and then include these into the regulation.

This law will run in parallel to the EU’s upcoming market abuse regulation (MAR) which clamps down on insider trading and sets out criminal sanctions.

MAR was endorsed by the European Parliament on 10 September, but final adoption will depend on a revision to interlinked EU financial regulation, the Market in Financial Instruments Directive (MiFID II). Isabel Save