European Union Benchmark Regulation: Practical implications of the ‘Third Country Regime’

In this blog Alex Lord, Audit & Advisory Director Deloitte explores the scope of the legislation on benchmark administrators based outside the European Union and the options available for them to ensure their benchmarks can continue to be used in the EU after 1 January 2020.

The European Union Benchmark Regulation (EU BMR) was effective 1 January 2018. While the transitional provisions mean that many of the requirements are not fully effective until 1 January 2020, benchmark administrators – particularly those based outside the European Union (EU) – need to take action to ensure they are prepared.

What is a third country administrator?

Any benchmark administrator based outside the EU that provides benchmarks or indices that are used in the EU by a supervised entity, will be subject to the third country regime requirements of EU BMR, and so will be defined as a third country administrator. Subject to the transitional requirements below, for the benchmarks administered by a third country administrator to continue to be used in the EU after 1 January 2020, the third country administrator must comply with the requirements of EU BMR.

Options for third country administrators

The legislation provides third country administrators with three options to comply with the requirements and continue to administer their benchmarks for use by EU supervised entity post 1 January 2020. In choosing which option is suitable, third country administrators should consider a number of factors including the benchmark’s current and potential future presence in the EU, the number of benchmarks in scope, as well as the complexity of administering the benchmarks.

1. Equivalence

The equivalence regimes set out under other pieces of EU legislation, EU BMR provides that the competent authority (i.e. the local relevant financial markets regulator) of the third country should adopt legislation or rules equivalent to EU BMR in their local jurisdictions and then seek approval from the EU for equivalence.

The equivalence option depends on third country competent authorities electing to seek equivalence with the EU. Given we are already some months into the transitional period, we encourage engagement between third country administrators and their competent authority as soon as possible to discuss whether equivalence will be sought.

Where equivalence is granted, the scope of any new rules or legislation implemented in the third country will depend on ESMA’s assessment of the third country’s current legal framework and supervisory practice This will be subject to an ESMA determination that the third country’s legal and supervisory framework is equivalent to the requirements set out in EU BMR or to the requirements of the IOSCO principles. Whatever the requirements, it is likely that third country administrators will need to apply for authorisation from their local third country competent authority.

Additionally, third country competent authorities may choose to limit the equivalence regime to specific benchmarks and/or administrators. Therefore, if a third country benchmark administrator is not included in the scope of the equivalence regime they will need to select either a recognition or endorsement option.

2. Recognition

Recognition requires an administrator located in a third country to have legal representation in the EU so regulatory oversight can be done by an EU competent authority. The EU legal representative will be required to carry out oversight responsibilities and will be accountable to provide third country benchmarks within the EU.

The location of the EU legal representative will depend on the third country administrator’s presence in the EU or where their existing third country benchmarks are being used in the EU. The regulation sets out a waterfall of requirements in Article 32(4) that assists third country administrators determine the location of the EU legal representative.

As part of the recognition application, the EU legal representative is required to evidence the third country administrator’s compliance with the IOSCO principles to the relevant EU competent authority. This can be achieved by engaging an external independent assurance provider to carry out an independent assessment or by a certification provided by the relevant third country competent authority.

3. Endorsement

For endorsement, third country administrators will need to engage an authorised EU benchmark administrator. The authorised benchmark administrator will then apply to its local competent authority for endorsement of the third country administrator’s benchmarks. This could be achieved through a commercial arrangement with the EU benchmark administrator that provides this service.

The EU benchmark administrator must demonstrate that it will have a well-defined role within the accountability framework of the third country administrator, and that it will supervise the administration of the endorsed third country benchmarks on an on-going basis.

The EU administrator will also need to prove to the competent authority that it has the necessary capabilities to monitor the provision of the third country benchmarks. Note that the regulation stipulates the endorsing administrator needs to provide an explanation for the provision of the endorsed benchmark in a third country and why it needs to be endorsed in the EU.

Timeline and transitional arrangements

The Q&A from ESMA issued on 8 November 2017 provided further clarity on third country transitional arrangements under EU BMR which differ from the transitional arrangements for EU countries. The diagram below highlights that third country benchmarks that can be used in the EU throughout the duration of the transitional period – up, to 31 December 2019.

Additionally, third country benchmarks that existed prior to 1 January 2020 can continue to be used in existing contracts post 1 January 2020 until maturity, without the need for the administrator to comply with EU BMR.

However, using existing benchmarks provided by third country administrators in new contracts created after 1 January 2020 is not permitted, where the third country administrator has not complied with the third country requirements of the regulation. Using benchmarks created by a third country administrator post 1 January 2020 is also not permitted, unless the benchmark complies with the third country requirements regulation.

Next steps

This is a series of considerations for third country administrators:

1. Consider if you want to continue to provide third country benchmarks in the EU

Third country administrators should assess how widely and to what extent their benchmarks are currently used within the EU. This will help them evaluate whether EU BMR compliance is necessary from a commercial perspective. Compliance may entail significant cost, which may not be justifiable. Administrators may determine that a better course of action would be to limit the use of their benchmarks to non-EU supervised entities after the necessary deadlines. Should they wish to continue to provide benchmarks to EU supervised entities beyond the relevant timelines, third country administrators should consider the following.

2. Establish whether an equivalence regime will come into effect

Third country administrators should seek to establish with their local authority whether there are any current plans to seek equivalence with ESMA.

If there are plans for equivalence, third country administrators may need to comply with new rules or requirements. For example, the IOSCO principles or, possibly, the requirements of the EU BMR which third country competent authorities may enforce locally. Third country administrators will need to be prepared, as the changes could be significant.

3. Evaluate whether recognition or endorsement is a better option

If no equivalence regime is sought, third country administrators will need to decide between recognition or endorsement.

Recognition: there will be cost implications in setting up an EU legal representative. The significance of these costs will depend on whether the third country administrator is a subsidiary or part of a group which also comprises EU supervised entities. Notwithstanding, third country administrators will need to consider how much work is needed to align their overall governance and control framework to the IOSCO principles and across geographies. Firms would also need to factor in the costs and benefits involved in obtaining independent assurance from an independent external auditor.

The proposed changes to various EU regulations by the European Commission published on 20 September 2017 could add a layer of complexity to the decision making. Currently the regulation requires third country administrators, together with their EU legal representative, to apply to the relevant local EU competent authority to seek authorisation for recognition. However, the proposed changes to ESMA’s powers could mean that third country administrators, together with their EU legal representative, could apply directly to ESMA. These proposals need to be agreed by the European Council and Parliament in negotiations and the entire process of finalising the rules can take 18 months or more. Firms should monitor any developments, but at the current time they will need to follow existing requirements for seeking recognition.by

Endorsement: this will mean partnering with an authorised EU benchmark administrator that would likely be external to the company. Firms must consider the suitability of this business relationship. Cost and operational considerations need to be assessed, as the endorsing company needs to be embedded within the firm’s governance framework and have a well-defined role in the accountability framework. These need to be assessed against the strategic objectives of the company, as well as regulatory efficiencies that endorsement could bring to third party administrators. This suitability assessment will also depend on the amount and complexity of benchmarks being endorsed.

4. Prepare for sustained IOSCO compliance

The Third Country Regime defined under the EU BMR clearly indicates that as a minimum, third country administrators should comply with the IOSCO principles for whichever option has been selected. Hence, we would encourage third country administrators to appropriately align their governance, risk and control framework for their benchmarks administration operations to the IOSCO principles.

Conclusion

Third country administrators should consider the costs and benefits of each of the options under the Third Country Regime. As we near the deadline for transitional arrangement, firms will need to decide on next steps, and start to implement their plans, engage with industry and regional forums throughout the transitional period, and formulate communication strategies to their clients and the markets in which they operate.

For further questions or discussions please contact Alex Lord.


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