4 December 2012, Brussels
Finance Watch today published its response to the European Commission’s “Consultation on a Possible Framework for the Regulation of the Production and Use of Indices serving as Benchmarks in Financial and other Contracts”, which was submitted to the Commission on 29 November.
Our response recommends that the Commission propose making all financial benchmarks and indices subject to strict supervision. The key points include:
- There is currently a regulatory gap around benchmarks, because financial instruments are regulated but the benchmarks on which many of them rely are not. New regulation should be wide in scope and cover all types of benchmarks (rate, equity, macroeconomic, etc.) and all uses (hedging, blueprinting for investment strategies, etc.).
- A European securities regulator should be given powers to oversee rate setting and calculation, with powers to investigate alleged misbehavior and if necessary to engage the civil liability of firms as well as the personal responsibility of operators and managers. In other words, if manipulation happens then the supervisor can hold the people responsible personally accountable.
- Benchmarks should be appropriate to their use. There can be a trade-off between a benchmark’s liquidity, which is useful for trading purposes and tends to benefit the benchmark user (typically an investment bank or asset manager), and its “basis risk” (the risk that a benchmark differs from the economic reality it is being used to reflect). Regulators should ensure that the appropriate benchmarks are used to avoid end-investors bearing more basis risk than they should.
- Mandatory transaction reporting: regulation should ensure a mechanical, transaction-based process for calculating indices wherever possible so they better reflect reality and are harder to cheat. The current system in which a key price can be based on a voluntary poll of traders with no audit trail has obvious risks. We would like to see a European-wide consolidated tape to centralize the exhaustive collection of information on executed trades, with similar mandatory exhaustive reporting of OTC transactions to trade repositories.
- Obligations on index providers and contributors. These would include duties to make transparent and full reporting to supervisors, and legal responsibilities if a failure in the way benchmarks are calculated leads to losses for investors and consumers.
Benoît Lallemand, senior research analyst and co-author of the consultation response, said:
“Financial benchmarks – including commodity price indices – are in most cases de facto public goods. Their social benefits should be maximized and the possibility for their miss-use tightly scrutinised. We would like to see a regulatory regime for the way benchmarks are produced and used to promote the core economic purpose of benchmarks and to safeguard their integrity.
In light of the recent high-profile problems with LIBOR and certain commodities benchmarks, a key question for regulators is what business model will best reduce conflicts of interest in this area.”
Thierry Philipponnat, Secretary General of Finance Watch, said:
“We support the Commission’s view that self-regulation in this area is not an option.”
Finance Watch has also asked the Commission to give consideration to evidence of the negative influence of commodity index funds on:
- the price formation mechanism of commodity derivatives markets: index funds increase dramatically the proportion of market participants that are not interested in physical delivery or hedging of spot prices – in a nutshell, participants with strictly speculative strategies;
- commodities spot prices: the amount of capital flowing into commodity derivatives or physical markets has put spot prices under increased pressure, while fundamental factors are already pushing prices up.
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