The Benchmarks Reform – Bigger than Brexit?

ABBL Published 08.03.2019

In the wake of major political and economic disruptions, the likes of Brexit, there is little need for further complications in the financial sector. This being said, more and more bankers whisper about yet another gargantuan operational challenge looming for the vast majority of the worldwide financial services sector.

It comes in the form of a set of benchmarks used to price more than EUR 400 trillion of financial products around the world.

Whether that’s the infamous London Interbank Offered Rate (LIBOR), little-known before the financial crisis and in the meantime synonymous with scandal, or the Euro Interbank Offered Rate (EURIBOR), even less known to the large public and the other main reference rate for the some of the world’s most liquid and active interest rate markets.

As a reminder, reference rates in financial contracts are rates that determine pay-offs in the financial contracts and that are, as a matter of principle, outside of the control of the contractual parties. They inherently reflect the credit risk in a financial transaction. The European Benchmarks Regulation (EU) 2016/1011 provides a more technical definition for benchmarks highlighting the different features that financial reference rates embody: an index[1] by reference to which the amount payable under a financial instrument[2], or the value of a financial instrument is determined or by reference to which the amount payable under a financial contract[3] is determined or that is used to measure the performance of an investment fund[4] with the purpose of tracking the return of such index, or defining the asset allocation of a portfolio or computing the performance fees.

What happens next?

Perceived as a risk to the regular functioning of financial markets, different legislative (e.g. the European Benchmarks Regulation) and regulatory efforts (e.g. the initiatives by the UK FCA) have been launched in the aftermath of the 2008 financial crisis to reform and gradually phase out the use of the traditional benchmarks in financial transactions. However, the prevalence of LIBOR and EURIBOR in all types of derivatives, loans, bonds and mortgages is proving a major problem for those assessing how to phase out the use of these behemoths.

Not left with a choice vis-à-vis the legislative and regulatory actions taken, the market has seen, over the course of the last months, the uprising of a series of “new” benchmarks in the form of, notably, SONIA (Sterling OverNight Index Average), EONIA (Euro OverNight Index Average), as well as a significantly modified EURIBOR. While there is little doubt that the “new kids on the block” are more robust and suitable in their methodology and structure, it is painfully obvious that the transitional period will be anything but a “piece of cake” – the most obvious problem is the vast number of outstanding loans and derivative contracts that still reference the traditional benchmarks and will remain in force after the end of the official transition period (in 2021).

How can the ABBL assist?

The ABBL assists its members in overcoming the significant challenges arising for them in the transitional phase, by providing technical support through a dedicated working group concentrating on the interim issues. The ABBL and its members have, inter alia, published a regulation overview which is available on the ABBL Membernet, and are working on a list of impacted products in Luxembourg.

Finally, the ABBL, in cooperation with ICMA Luxembourg and the Luxembourg Financial Markets Association (LFMA), is also hosting a major conference on the topic on the afternoon of 18 March 2019. Speakers include the Secretary General of the European Money Markets Institute (EMMI), experts hailing from the UK and French market, as well as Luxembourg specialists in charge of leading our members through the turbulent times ahead.

[1] Any figure that is published or made available to the public, and that is regularly determined entirely or partially, by the application of a formula or any other method of calculation, or by an assessment, and on the basis of the value of one or more underlying assets, or prices, including estimated prices, actual or estimated interest rates, quotes and committed quotes, or other value or surveys.
[2] Any instrument listed in Section C of Annex I of MiFID II for which a request for admission to trading on a trading venue has been made, which is traded on a trading venue, or which is traded via a systematic internaliser.
[3] Any credit agreement as defined in the Consumer Credit Directive, or the Mortgage Credit Directive.
[4] Any UCITS or AIF.

 

By Gilles Walers, ABBL Legal Adviser

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