February 9th, 2018 by Nick Railton-Edwards
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Overshadowed by the MiFID 2 regulatory colossus, the start of the year also marked the coming into force of the EU’s Benchmark Regulation (BMR). As well as defining and categorising benchmarks, the BMR lays down obligations that affect both administrators and users, requiring firms to prepare written plans detailing their response to the cessation, material change to or de-authorisation of benchmarks. The Regulation requires such contingency plans to be contained in contractual arrangements that make reference to benchmarks. Although the BMR has extra-territorial reach via EU users of “foreign” benchmarks, requiring decisions as to equivalence, recognition or endorsement; benchmark bother has largely been a European affair. This changed on 5 January with IOSCO’s short statement “Matters to Consider in the Use of Financial Benchmarks” echoing (if not entirely parroting) the BMR’s contingency planning prescriptions.

The likely global rollout of benchmark regulation does not necessarily entail a vast repapering exercise. The majority of derivatives contracts[1] make reference to the ISDA definitions by asset class (as updated and amended etc.) all of which contain fallback provisions to deal with contingencies previewed in the BMR and IOSCO statement. It will however require firms to perform a portfolio analysis to highlight those contracts which do not contain adequate fallbacks and require consequent remediation and amendment. Even in the absence of global bench regulation parity, it is clearly advisable to eliminate legal basis risk by conforming other contracts to the BMR “benchmark”.

The various (mainly L) IBORS are the benchmark royalty both by importance and scandalous history. Their situation is more complex- the BMR puts rules in place for what happens after a benchmark “King/Queen” goes mad temporarily or otherwise; by contrast, the global IBOR royalty are being replaced piecemeal by a hoi polloi of location-specific overnight rates. Contracts will require amendment to both replace the benchmark rate and allow for credit risk replicating spreads and  compounding to convert “X-ONIA” to 3, 6, 9 etc. month rates. To extend (the already stretched) metaphor, LIBOR the (multi-currency) emperor of IBORS is facing the guillotine. July 2017, the FCA announced that banks would not be compelled to submit LIBOR reference rates from the end of 2021. This is a distant horizon to hard-pressed, reactive Regulatory Change managers, but the market should expect LIBOR- referenced liquidity to dry up well in advance of its well-flagged death date. LIBOR is an interesting case insofar as it will test existing fallback clauses which generally refer to the temporary suspension of rate publications rather than their abolition; clauses need to be assessed for their suitability in this regard.

Firms should be aware that the BMR is likely to be just the first chapter of a global re-benchmarking saga. The need for remediation will depend on the specifics of particular contract, asset class and jurisdiction. If benchmark replacement implies or requires a valuation change in the contract, the legal situation becomes exponentially more complex. Specificity requires in-depth knowledge of all affected contracts. This is a task that cannot be done just prior to regulatory imperative.

 

[1] Note- benchmark-referenced loans, mortgages, bonds et al. do not reference the ISDA definitions

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