ESMA sets out benchmark parameters for extreme market stress scenarios

The EU’s securities regulator has said benchmark administrators should explain in detail any deviations from their methodology in times of extreme market conditions, after financial institutions noted rebalancing delays at the onset of the covid-19 crisis.

The European Securities and Markets Authority (ESMA) published a final report containing new sets of draft regulatory technical standards (RTS) under the EU’s Benchmarks Regulation on 29 September.

The report takes on board comments from respondents to a consultation paper ESMA issued on its RTS in March, particularly with respect to administrators’ exercise of their discretion in determining benchmarks.

With the covid-19 pandemic unfolding as the consultation opened, several respondents noted that some benchmark administrators decided to delay rebalancing amid the extreme market conditions that accompanied the crisis.

They argued that while the administrator rulebook entitled administrators to exercise discretion, such decisions could have financial consequences on investors and pension funds. They called for additional transparency whenever such discretion is used and said regulators should lay out standards to guide any similar decisions in the future.

In response, ESMA’s final report says that benchmark administrators should legitimately explain any disruption from using transaction data or any other deviation from the standard methodology.

The authority said that benchmark administrators should provide detailed information of how transaction data in the underlying market would be deemed “not sufficient”.

It also said administrators would have to specify which components of the methodology could not be applied, and when they would be able to exercise discretion in determining the benchmark.

ESMA also commented that it would “further assess” the need for additional guidance on the use of discretion.

Remuneration framework changes

In its consultation paper, ESMA initially said that in order to minimise conflicts of interest, benchmark administrators should establish a remuneration framework that ensuring the remuneration of individuals involved in the provision of the benchmark are “appropriately set” and are not subject to conflicts of interest.

But in its final report, ESMA removed the words “appropriately set” after respondents said the phrase lacked clarity.

Market participants will instead follow IOSCO’s principles for financial benchmarks, which encourage institutions to set remuneration policies for staff that are not “rewarded or incentivised” by the levels of the benchmark.

It also exempted “non-significant” benchmarks from applying the remuneration framework, after respondents called for increased proportionality with this requirement. The authority says this will minimise the burden on administrators of such benchmarks.

ESMA is mandated to develop RTS under several articles of the EU’s Benchmarks Regulation. These include specifying aspects of governance arrangements, a consistent methodological framework and a method that ensures the integrity of input data of each benchmark.

ESMA submitted the draft RTS to the European Commission on 1 October, and the Commission has three months to decide whether to endorse the regulatory technical standards.

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