IOSCO published a statement setting out matters for users of financial benchmarks (benchmarks) to consider in selecting an appropriate benchmark and in contingency planning, particularly for scenarios in which a benchmark is no longer available.
It is intended to help inform benchmark users and to complement existing IOSCO Principles.
First, there are matters related to assessing the appropriateness of a benchmark, in both its initial selection and ongoing use. Second, there are matters related to contingency planning, such as if the selected benchmark becomes unavailable. In both cases, the statement recognises users’ reliance on benchmarks, aims to increase awareness of the risks involved and encourages their mitigation, where appropriate.
The statement recognizes that, in many instances, users of benchmarks may not be able to provide any input to the characteristics of a benchmark or the terms of existing financial instruments which reference them. In cases where a benchmark is used in a contract between a financial firm and a retail client, for example, the retail client is likely to have little ability to change contractual terms. The financial firm is likely to have responsibilities towards that client. In considering the matters set out in the statement, it would also therefore be appropriate for the financial firm to consider its client’s interests in a manner consistent with those responsibilities.
Examples of relevant considerations of appropriateness for a user could be, to the extent they are applicable:
- the way in which the benchmark is determined, including the size, liquidity and potential evolution of the market being measured by the benchmark and other aspects of the relevant methodology, along with the transparency of the methodology;
- whether the benchmark provides an appropriately accurate and reliable representation of the market it seeks to measure, and is likely to remain so, and how factors that might result in a distortion of the price, rate, index or value of the benchmark are eliminated or reduced;
- in the case of interest rate benchmarks, whether or not it is desirable or necessary for the benchmark to include a term risk or credit risk element;
- how the benchmark is disseminated to users;
- the governance of, and accountability for, the benchmark determination process;
- the process by which changes to the benchmark’s methodology can be made, e.g. relevant
- how the administrator deals with significant decisions affecting the compilation of the benchmark and any related determination process, including contingency measures in the eventcof insufficient or no inputs (e.g. the use of expert judgment), market stress or disruption, and
failure of critical infrastructure;
- the provisions which could apply in the event of material changes to the benchmark and how they would operate in practice; and
- whether, and under what circumstances, provisions relating to cessation of the benchmark should apply.
The considerations may vary depending on the circumstances, including the characteristics of the user and the types of contract or financial instrument referencing the benchmark. Users are encouraged to assess the relevant considerations not only on the initial selection of a benchmark, but periodically on an ongoing basis, as circumstances indicate.
The existence and operation of robust fall back provisions could help protect the users (and their clients, as applicable) against the risks of relying on a particular benchmark. They may help reduce or prevent
potential wider market disruption. More specifically, if a permanent discontinuation of an IBOR or other benchmark occurs, the fall back provisions would need to be robust enough to prevent potentially
serious disruption to markets and market participants (including users and their clients), and to safeguard the continuity of contracts, as a result.
- In determining the suitability of a particular alternative rate or figure, factors that would be important for users to consider, as appropriate, include:
- how credible the alternative rate or figure would be, including how closely the alternative matches the original benchmark’s characteristics, how economic differentials between the
alternative rate or figure and the original benchmark figure are minimised, the extent to which an alternative rate or figure meets the needs of the parties and the availability of data on the alternative rate or figure;
- whether and how the original benchmark and the alternative rate or figure could be maintained in parallel for some time in order to accommodate an orderly transition to a new benchmark;
- the time at which the fall back rate or figure would start to operate, taking into account the term of the contracts and the tenor of the financial instruments referencing the benchmarks, and the adequacy of notice involved; and
- the impact on the economic value of the financial contracts and instruments referencing the benchmark, in particular ensuring that the alternative rate or figure would be reasonable and fair.