Scrambling on MiFID? Don’t Forget a Coming Benchmark Change

(Bloomberg) -- Banks racing to be ready for MiFID II in January are overlooking a separate regulation designed to combat the kind of Libor-style manipulation that cost them billions of dollars in fines.

The European Union’s benchmark rule will cover trillions of dollars of assets from January. The aim is to create more transparency about how values are set for everything from credit-default swaps to the mortgage rate you pay and even the price of milk. An infringement of the rules, which cover millions of indexes, can lead to a fine of as much as 2 percent of a parent company’s sales.

“This is not on a lot of people’s radar screens as it comes into effect at the same time as” the revised Markets in Financial Instruments Directive, said Rick Redding, chief executive officer at the New York-based Index Industry Association, the trade body that represents providers including FTSE Russell and S&P Dow Jones Indices. “Everyone is more focused on MiFID rather than the benchmark regulation.”

The new EU regime covers indexes such as the FTSE 100 and others created by money managers internally to measure performance or to help allocate assets. It’s designed to remove an inherent conflict where the firms that set benchmarks previously had the most to gain from the figures chosen. Some traders previously fiddled with the rates for their own profit, creating some of the banking industry’s biggest scandals, so much so that regulators will phase out the London interbank offered rate completely by 2021.

Underestimating Effect

“Most market participants have underestimated its effect,” said Andrew Sulston, a partner at U.K. law firm Allen & Overy. “This is a pretty significant compliance hurdle. People are less aware of the benchmark regulation, or, if they are aware they might be making the assumption that it’s only really there to deal with the very public benchmarks such as Ibors.”

Benchmarks track the aggregated value of assets such as commodities and stocks and, by providing the basis for many transactions, determine the amount to be paid in trillions of dollars of financial contracts.

The new rules mean that benchmarks sold to the finance industry in Europe will be governed for the first time. Index manufacturers, including banks and asset managers, will need to get regulatory approval for each one they administer and appoint staff to oversee their governance on a daily basis, increasing compliance costs.

If you just use the indexes, the price of the regulation is “relatively cheap but if you are an administrator the cost is a lot higher,” said Bruno Piers de Raveschoot, chief operating officer at the regulatory division at financial data manager RIMES Technologies. 

Lobbyists say banks they represent are suffering from regulatory change overload and resources are being put into preparing for other difficulties including Brexit and MiFID II, which overhauls trade execution and research, according to a person with knowledge of the matter. Benchmark changes are a lower priority, the person said, declining to be identified as they weren’t authorized to discuss the matter publicly.

Compliance teams on the asset manager side are also stretched preparing for MiFID II and other rules that improve disclosures around costs and risks to investors. Under the changes, money managers have to audit the indexes and rank their importance from “non-significant” to “critical”, increasing the regulatory burden. 

Not everyone agrees that asset overseers are unprepared for the changes. The regulation has been well anticipated, said Giles Swan, director of global funds policy at the Investment Company Institute trade association.

Global Impact

Still, firms outside the EU are not paying enough attention to the change, presuming it would only apply to the region and are now scrambling to get ready to implement it, said Redding at the Index Industry Association. The regulation may also become a global one because it requires each provider to comply if they sell into the political bloc.

The lobby group says the regime has a disproportionate impact because of the range of indexes it covers, whereas some countries have designed specific regimes to deal with critical benchmarks like interbank offered rates in Japan, Singapore and the U.K.

“There’s regulatory fatigue and no resources in the City at the moment” for firms coming late to the changes, said Jake Green, financial regulation partner at global law firm Ashurst. “Top of people’s risks tends to be MiFID, unless they are the biggest administrators of indices on the planet.”

©2017 Bloomberg L.P.