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Consultation on a Possible Framework for the Regulation of the
Production and Use of Indices serving as Benchmarks in
Financial and other Contracts
Answers of the Federal Financial Supervisory Authority (BaFin
(Germany))
Chapter 1. Indices and Benchmarks: What they are, who
produces them and for which purposes
1.
As a financial regulatory authority, BaFin does not produce
benchmarks. We also do not contribute data.
2.
BaFin uses benchmarks rather indirectly in the supervisory
practice. For example BaFin staff analyzing potential market
abuse or insider trading uses benchmarks for examining the
market impact of (corporate) news. Also the research department
uses benchmarks when monitoring macroeconomic risks.
Benchmarks may be also a source when analyzing investment
fund performances.
3.
No.
4.
Products that are supervised by BaFin and which are referenced
to indices are index-tracking investment funds (mainly Exchange
Traded Funds (ETFs)) and securities (notes/certificates) publicly
offered. There are 105 index-tracking ETF authorized in
Germany. The market volume is about 31 bn. Euro. Securities
referenced to indices (non-interest benchmarks) are about
180,000 with a market volume of about 21 bn. Euro.
5.
See above.
6.
There are various benchmarks used in our jurisdiction based on
transaction data, panel submission etc. For examples see answer
to question 8. Regulatory requirements to the basement of
benchmarks apply only with regard to investment funds tracking
indices. For a full description of the index requirements, see art.
9 and 12 Directive 2007/16/EC and the provisions set out in the
recently published ESMA Guidelines on ETF and other UCITS
issues. Relevant provisions are, e.g., that they are constructed
with sound procedures to collect prices, including pricing
procedures for components where a market price is not available
and that the methodology is fully transparent.
7.
Most important factors would be:
• A robust, fully transparent and understandable methodology for
calculation;
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• Credible governance structures; Adequate controls must be in
place; adequate processes for identifying, avoiding and, if this is
not possible, managing conflict of interest
• An appropriate degree of formal oversight and regulation (e.g.
registration of certain benchmark providers)
• The use of transaction data to the extent possible
• Transparency and openness; calculation methodology and
(types) of data should be freely available
An example for a benchmark fulfilling these criteria would be the
DAX-30 index.
Chapter 2. Calculation of Benchmarks: Governance and
Transparency.
8.
In the following the most important benchmarks in economic
terms for the German financial markets are covered. The equity
indices of DAX and Eurostoxx, the sovereign bond indices of REX,
settlement prices at the Eurex exchange and the interest
reference rate EONIA (European OverNight Index Average) are
all based on actual transactions in the underlying market. Foreign
Exchange Reference Rates by the ECB are based on a regular
daily concertation procedure between central banks across
Europe and worldwide. CDS-spreads of single-names and indices
(e.g. iTraxx) sponsored by Markit are based on quotes by
contributors (e.g. market-makers). The interest reference rates
EURIBOR and LIBOR are based on submitted estimates for
unsecured borrowing costs by contributing banks.
9.
No. There may only be an advantage when no reliable actual data
exist (e.g. no relevant trading or illiquid markets). Then
estimates based on statistical methods could be useful.
10.
Using transaction data would reduce the vulnerability of
benchmarks. Only in cases where no transaction data exist but
the price information is deemed indispensable in order that the
benchmark represents the market adequately, estimated or
modelled prices by using statistical techniques could be a solution
which would lead to a mixture of transaction and estimated data.
In any case, the fact that data are “model based” as well as the
pricing procedures would need to be disclosed.
11.
The benefits are the reduction of vulnerability. But also generally,
the goal of a benchmark is to adequately represent the market to
which it refers, which would be best achieved by using actual and
reliable transaction data. Hence, the use of transaction data
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would improve the economic quality of the benchmark since it
would better represent ma ket activities.
12.
Banks which submit quotes to the calculation of Benchmarks
should do so in accordance with certain rules of conduct. With
regard to those German banks which submit quotations for LIBOR
and EURIBOR, BaFin has drawn up a catalogue of principles,
which banks in the future have to adhere to:
• Four eyes principle as regards the verification of quotes, which
should ensure that conflicts of interest are avoided
• Detailed documentation, which should include the grounds for a
quotation (e.g. actual transactions)
• Clearly formulated procedures and clear personal
responsibilities
• Regular review by a unit, which is not involved in the
quotations process (e.g. compliance), and regular internal audits
• Reporting to senior management if irregularities are identified
by compliance or internal audit
These principles established for banks may serve as a blueprint
for bechmark (and benchmark data) providers outside the
current regulatory scope. Specifically, private sector providers of
benchmarks, that are relevant for financial instruments in
regulated markets, shall be obliged to register with the
competent regulatory authority.
The details and terms of reference benchmarks should be
disclosed, e.g. in a prospectus.
13.
Self-regulation alone, e.g. through a code of conduct, cannot
ensure the integrity of the submission process. The basic
principles of a proper business organization, which should also
apply to the submission process, need to be defined in statutory
regulation. The function of a code of conduct could be to spell out
these principles in more detail in the context of a specific
benchmark.
14.
Contributions to the calculation of benchmarks should be subject
to the same rules of conduct as any other business activity which
banks undertake. At least in German law it is not necessary to
explicitly make the submission of quotes a regulated activity.
The submission of inaccurate quotes could be sanctioned under a
market abuse regime. Depending on the specifics of the
benchmark it might however be difficult to provide evidence for a
deliberately inaccurate submission.
15.
Not applicable.
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16.
Panels should be chosen in order that the resulting benchmark
adequately represents the market. However, there should be
conditions for the panel contributors. E.g., they should have
proper organisational mechanisms in place. They need to have
adequate processes for identifying, avoiding and, if this is not
possible, managing conflict of interest. They should have
processes for producing and documenting their contributions in a
clear and transparent way.
17.
To ensure the representativeness and integrity of the data,
survey data should be:
• verified by the benchmark sponsor, e.g. by verifying
documentation and cross-checking
• published in order to enhance transparency
• scrutinized intensively by the benchmark sponsor (e.g.
checking for unusual changes in submissions)
• adjusted by calculating benchmarks as adjusted averages
(elimination of outliers) to reduce the vulnerability for
manipulation
• deducted by contributors in accordance to clear guidelines
18.
Large panels will reduce the risk of manipulation and misconduct.
It would also improve the economic quality of the benchmark
since it would better represent market activities. A greater
geographical dispersion of the participants would also support the
goal of having a representative and economically meaningful
benchmark.
19.
See replies to questions 28 and 29.
20.
Potential litigation risks that may arise from a firms participation
and increased regulatory burdens could potentially result in
contributors exiting the benchmark setting process. Benchmarks
themselves share some of the characteristics of a public good,
meaning that their benefits are not exclusive to the submitters.
21.
Mandatory reporting requirements could prove useful, as they
increase the share of the market that is represented by the
benchmark. However, a threshold (e.g. market share) should be
considered to avoid excessive burdens on minor submitters who
do not significantly contribute to the representativeness of the
benchmark.
22.
Allowing the regulator to exercise control and oversight over
individuals as well as firms, will significantly increase the ability
of authorities to oversee benchmarks effectively and take action
in relation to any misconduct. The existence of sanctions will
provide a powerful incentive on firms to ensure they act properly
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and in compliance with the relevant regulatory requirements.
Disadvantages would be increased compliance costs for firms and
an increased supervisory burden on the regulator.
23.
It is advisable to have the responsibility for adjustments of
inadequate data – if any – rest with the index provider.
Currently, grounds for supervisory measures with regards to the
index provider are being developed and shall include adequate
elements of governance, transparency and non-discriminatory
access to the relevant index information.
24.
Currently, there is no formal auditing process with regards to the
index provider.
25.
Not applicable.
26.
The internal audit controls of data contributors are being
evaluated; so far, audit controls appear to have been insufficient.
More severe control mechanisms are likely to be necessary and
will eventually be based upon the final outcome of the ongoing
evaluation. However, under current legislation, audit control
measures and validation procedures can only effect contributors
as index providers and publishers are outside the scope of
regulation.
27.
With regards to the index provider, a formalized validation
procedure would allow for a general plausibility control; with
regards to the contributors of relevant data, integrity is likely to
increase significantly.
Generally, advantages are an increase of integrity and reliability
while on the other hand formal procuders will increase the costs
of index provision and possibly supervision and may make
market proximity hard to achieve.
28.
As opposed to the process of validation, responsibility for a final
audit should not rest with the index provider. Instead, the
responsibility depends on the nature, depth and frequency of the
audit required de lege ferenda and should be conducted either by
the supervisory authority or an independent auditor in
accordance therewith.
29.
Generally, any governmental regulation of benchmark activity
should be installed with caution and should concentrate on those
rates that are frequently used by the markets and are (due to
their nature) open for manipulation. While regulation would
presumably increase the participants‘ integrity and awareness, it
may on the other hand in some areas create an inadequate
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demand of effort and thereby make the use of benchmarks
generally less feasible.
Chapter 3: The Purpose and Use of Benchmarks
30.
Generally, the use of benchmarks may be restricted. For
investment funds, as an example, the use of benchmarks is
already restricted. Provisions for the use of indices (either with
regard to index-tracking or the use of derivatives which refer to
indices) apply in Europe to all UCITS.
Please refer to the answer to question 6.
31.
Such strict allocation of specific benchmarks is considered
problematic for the respective activities and terms of use would
have to be determined beforehand. Obviously, this may only be
feasible e.g. with large standardized contracts. Currently, BaFin
sees no grounds for intervention or regulation.
32.
Generally, there are no objections against the use of „wholesale“
benchmarks in retail contracts. A level playing field should be
aimed at with respect to the control of non-financial benchmarks
in relation to the terms to be established in the financial sector.
Wherever there are nonfinancial regulatory (public) institutions
involved, a reasonable level of cooperation should be established
and/or upheld.
33.
The allocation of responsibility depends on the regulatory
measures taken, for responsibility itself may otherwise not be
enforced. With regard to regulated entities, some degree of
responsibility may always be assumed for reputational reasons,
regardless of the actual regulation.
Chapter 4: Provision of Benchmarks by Private or Public Bodies
34.
The qualification as a public good has to be determined
individually, whereby aspects such as non-rivalry and nonexcludability have to be taken into account. Currently, none of
the known indices are considered a public good.
35.
It may be appropriate to distingiush between benchmarks
provided by public or private institutions: While benchmarks
provided by a public body are already subject to regulation on
another (i.e. institutional) level and therefore do not need any
further governance by (e.g.) financial regulators, private
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benchmark providers should be governed along the terms
established above (see answer to question 12).
36.
Advantages:
• less potential conflicts of interest in the collection of data (given
no governmental issues are concerned)
• public influence in the compilation process may be possible
Disadvantages:
• potential conflicts of interest whenever other governmental
goals may be concerned (e.g. potentially low inflation rates in
times of economic crisis)
• possibly less flexibility and speed in development or adopting to
new circumstances
• possibly less variety because of the limited number of potential
index
providers and lack of competition
37.
There is no obvious reason for a general provision of benchmarks
by public bodies. However, in the event of market failure (e.g.
public good) a public body may adopt the role oft he provider.
Chapter 5: Impact of Potential Regulation: Transition, Continuity
and International Issues.
38.
The public index provider’s neutrality may be endangered
whenever other governmental issues are concerned. Hence, the
less dependent a public provider is on the government, the less
conflicts of interest may arise (e.g. public foundation vs.
administrative body).
39.
One of the challenges is whether there is an appropriate and
eligible alternative to an existing index or benchmark or not.
Contract parties chose an existing benchmark or index for some
specific reasons and the question is whether or not the
alternative benchmark can cope with these requirements.
Another crucial factor with respect to liquidity issues is the
acceptance of the alternative benchmark.
Market-led transitions from one benchmark to another, e.g. from
FIBOR to LIBOR, took place as a result of surrounding
circumstances and changes. We are not aware that impact
assessments were conducted. With regard to an estimate of
future costs experiences from better regulation-efforts. i.e. other
impact assessments, suggest that the costs will not fall below an
amount of EUR 50,00 per transition per object.
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40.
While a mandatory use of benchmarks is generally seen as
problematic (see answer to question 31), in cases of a transition
from one benchmark to another regulatory measures may be
considered.
41.
Coordinated action by all relevant financial market places is of
the essence in order to avoid regulatory arbitrage. Within the
European Union, respective legal measures should be taken.
42. + 43. Any change in the way a benchmark is calculated has a
potential impact on the value of this benchmark and its future
development. Such an effect would likely be brought about by
the introduction of new regulation as well as by the better
enforcement of existing regulation with regard to the calculation
of a benchmark or index. However, it is not the task of financial
regulation and supervision to consider the commercial interests
of small and medium-sized enterprises or of other private or legal
persons which have been trading in financial instruments based
on a certain benchmark or have taken out a loan with a variable
interest rate. Instead regulation and supervision should only seek
to ensure the integrity and stability of financial markets.
44.
Not applicable (no direct us of benchmarks in the regulatory
sector, see reply to question 1-3).
45.
Not applicable (see reply to question 44).
46.
Not applicable (see reply to question 44).