16 May 2013

NYSE Euronext’s Response to IOSCO’s “Consultation Report on Principles for Financial Benchmarks”

1.

NYSE Euronext

1.1

NYSE Euronext is a leading global operator of financial markets, a manager of index and other referential data and a provider of innovative trading technologies. NYSE Euronext’s regulated markets in Europe (Amsterdam, Brussels, Lisbon, London and Paris) and exchanges in the United States provide for the trading of cash equities, bonds, futures, options, and other Exchange-traded products. NYSE Liffe is the name of NYSE Euronext’s European derivatives business and is the world’s second largest derivatives business by value of trading. It comprises regulated markets in five EU Member States which operate on the basis of the Markets in Financial Instruments Directive (“MIFID”). In addition, NYSE Euronext has over 25 years of experience in compiling, calculating and publishing a wide range of benchmark indices in Europe and the United States, including the CAC 40 and AEX indices.

1.2

NYSE Liffe makes available for trading a broad range of futures and options contracts, including products based on Sterling LIBOR, Swiss Franc LIBOR and EURIBOR. In addition, NYSE Euronext’s futures exchange in the United States, NYSE Liffe U.S., lists a futures contract based on U.S. Dollar LIBOR and has recently launched a product based on the DTCC’s General Collateral Finance (“GCF”) Repo Index.

1.3

NYSE Euronext’s company address is as follows: 11 Wall Street New York 10005 United States

39 rue Cambon 75039 Paris France

2.

General Comments

2.1

NYSE Euronext welcomes IOSCO’s “Consultation Report on Principles for Financial Benchmarks” (“the Consultation Report”), as well as the regulatory initiatives which are underway in the UK (i.e. implementation of the conclusions of the Wheatley Review of LIBOR) and other work – in addition to IOSCO’s - which is being conducted internationally (e.g. the review by the European Commission on the production and use of indices serving as benchmarks in financial and other contracts). The level of scrutiny by policy makers and

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regulatory authorities at the present time is extremely positive both in terms of finding a practical and effective solution to the issues which have been identified by the regulatory authorities and in preventing the occurrence of further misconduct and abuse, as well as enhancing the fitness for purpose of relevant benchmarks. 2.2

Given the degree of diversity in financial benchmarks, and in the sources and characteristics of their inputs, NYSE Euronext believes it is necessary to place them into the following three categories for the purposes of considering policy action: (a) Category 1: benchmarks based on polled rates which are sourced from Over The Counter (“OTC”) markets. (b) Category 2: benchmarks based, in whole or in part1, on transaction data from OTC markets. (c) Category 3: benchmarks based on transaction data from regulated markets.

2.3

Regulatory authorities have recently identified misconduct in, and have taken disciplinary action against attempted manipulation of, a number of benchmarks in Category 1, most notably in the cases of the London Inter Bank Offered Rate (“LIBOR”) and the Euro Inter Bank Offered Rate (“EURIBOR”). In the case of LIBOR, a comprehensive package of measures is already being implemented in order to strengthen its governance, regulation and calculation methodology which NYSE Euronext fully supports 2.

2.4

Separately, IOSCO has examined the efficacy of some benchmarks within Category 2 as a result of concerns about their reliability, principally due to selective reporting of data and opacity and variations in assessment methodologies 3. Benchmarks within Category 2 warrant further scrutiny given that the OTC markets from which the relevant data is derived are not subject to orderly and proper markets requirements, nor are they transparent or multilateral in nature.

2.5

In contrast, whilst benchmarks in Category 3 are not immune from regulatory failure – and whilst they are also within the scope of IOSCO’s current work – their governance and operation have not been the subject of serious regulatory concern, nor have the regulatory authorities identified any demonstrable misconduct in relation to their compilation. A key differentiating factor of benchmarks within Category 3 is that typically they are calculated on the basis of the price of shares traded on regulated markets. Those regulated markets are required to comply with stringent regulations concerning market integrity, orderly and transparent price formation, and the operation of proper markets. Moreover, their compliance with such regulations is subject to close and continuous oversight by the

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Some of the benchmarks in Category 2 are calculated using a hybrid methodology which incorporates data on bids and offers as well as transactions. 2 See “The Wheatley Review of LIBOR: Final Report”, dated September 2012. 3 See “Principles for Oil Price Reporting Agencies: Final Report”, dated 5 October 2012 which explains on page 6 that “IOSCO has examined numerous PRA processes for the purposes of identifying common vulnerabilities that could, if not addressed by appropriate controls and policies, result in an assessed price that is an unreliable indicator of the physical oil market value that it is intended to reflect”.

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relevant regulatory authorities. Furthermore, regulated markets do not “submit” inputs to equity index administrators in the active fashion - requiring the rigorous management of potential conflicts of interest - that is envisaged in the concept of a “submitter”. 2.6

In light of these considerations, NYSE Euronext believes that it would be appropriate for the following framework to be established: (a) all benchmarks should be brought within the scope of civil and criminal sanctions against manipulation 4, and their governance, transparency and calculation methodology arrangements should be subject to a set of high level principles devised by IOSCO; (b) In addition, the administration of 5, and the process of contributing to, benchmarks within Categories 1 and 2 should be regulated activities. This would enable regulatory authorities to create bespoke regulations and associated sanctions in relation to these activities. That new regulatory regime should be supported by enabling provisions which would enable it to be extended, where necessary, to any benchmarks within Category 3 (e.g. if in future any such benchmark were to suffer from significant regulatory failure).

2.7

Turning to the Consultation Report itself, NYSE Euronext broadly supports the scope and substantive provisions of the Principles for Financial Benchmarks (“the Principles”) that IOSCO proposes.

2.8

NYSE Euronext would, however, recommend that amendments be made in the following areas: (a)

Definition of Benchmark: under the definition as currently drafted, the price of an individual financial instrument would be classified as a “Benchmark”. The corollary of this is that each Regulated Market and Exchange would be classified by the Principles as a “Benchmark Administrator” simply by virtue of its operation of a trading system through which the price of such financial instrument is determined. NYSE Euronext recommends that the Principles be amended to make it clear that this is not the intention.

(b)

Data Sufficiency: as currently drafted, the Principle on Data Sufficiency does not take into account the design and construction of submission-based benchmarks. Nor does it adequately reflect recent regulatory changes in respect of LIBOR, which now require a greater use of transaction data to corroborate submissions.

(c)

“Expert Judgement”: the Principles appear to be based on a misconception that, in relation to submission-based benchmarks, the benchmark administrator will be the entity that is exercising Expert Judgement in the determination of the benchmark on

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This is already being taken forward within the EU as a result of the proposed extension of the Market Abuse Regulation and Market Abuse Directive to cover the manipulation of benchmarks. 5 The only exception to this rule would be the administration of those benchmarks which are managed by public authorities, such as the inflation indices which are produced by the UK Office of National Statistics.

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a day-to-day basis. That is not the case. Instead, Expert Judgement will be exercised by benchmark submitters in the determination of their individual submissions to the benchmark. (d)

Definition of “Submitter”: the current definition of “Submitter” is too broad as it would potentially cover a stock exchange in circumstances in which prices established in its market are used in equity indices. NYSE Euronext assumes this is unintended as it would impose on stock exchanges the same obligations that are intended for contributors to benchmarks which are genuinely submission-based (e.g. LIBOR).

2.9

The points raised in paragraph 2.8 are explained in more detail in section 3 of this paper.

3.

Answers to the Questions Raised in The Consultation Report

3.1

This section of the paper provides answers to the specific questions which are raised in the Consultation Report. The questions from the Consultation Report are reproduced in bold italic text. In each case, they are followed by NYSE Euronext’s response, which is shown in normal text.

3.2

Question 1 - Equity Indices: Indices may be used to measure a wide range of underlying Interests, using a variety of calculation methodologies and inputs. In the specific case of equity indices, inputs are typically based on transactions concluded on Regulated Markets. In light of this: are there any principles or parts of the principles that cannot, or should not, be applied to equity indices? If so, please identify these principles and explain why their application is inappropriate.

3.3

Whilst equity indices are not immune from regulatory failure, their governance and operation have not been the subject of serious regulatory concern, nor have the regulatory authorities identified any demonstrable misconduct in relation to their compilation. As IOSCO recognises in the Consultation Report, a key differentiating factor between equity indices and many other types of financial benchmark is that typically equity indices are calculated on the basis of the price of shares traded on regulated markets. Those regulated markets are required to comply with stringent regulations concerning market integrity, orderly and transparent price formation, and the operation of proper markets. Moreover, their compliance with such regulations is subject to close and continuous oversight by the relevant regulatory authorities. It is for these reasons that NYSE Euronext has proposed that the regulatory framework which is explained in paragraphs 2.2-2.6 above should be implemented 6. In other words, as a general matter NYSE Euronext supports the application of the Principles to equity indices.

3.4

Notwithstanding NYSE Euronext’s general position, it agrees that given the nature of equity indices (and, indeed, other benchmarks within Category 3) it is appropriate to consider

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Equity indices would fall within Category 3 in that framework.

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whether some of the Principles cannot or should not be applied to such benchmarks. NYSE Euronext believes that this exercise has already been conducted satisfactorily by IOSCO creating a core set of provisions within the Principles – which apply to all benchmarks – and supplementing them with additional provisions which will apply only to benchmarks based on submissions. The only proviso that NYSE Euronext would add is that the current definition of “Submitter” is too broad as it would potentially cover a stock exchange in circumstances in which prices established in its market are used in equity indices, which we assume is unintended (please see the answer to Question 4 below which suggests how the definition could be amended). 3.5

Question 2 – Additional measures to address the risks resulting from Submission-based Benchmarks or ownership or control structures: Additional measures have been specified within certain principles to address specific risks arising from a reliance on Submissions (Principles 4, 10, 13 and 17) and/or from ownership or control structures (Principles 2, 5 and 16). (a)

3.6

Should these additional requirements apply to Submitters and Administrators of all submission-based Benchmarks or Benchmarks with the specified ownership/control structures?

Yes, because all such benchmarks are potentially susceptible to an exploitation of conflicts of interest, which need to be actively managed if they are to be effectively mitigated. This answer is subject to amending the definition of “Submitter” as suggested in the answer to Question 4 below. (b)

If not, please explain why all or some Submission-based Benchmarks or Benchmarks with the specified ownership/control structures should be exempt.

3.7

No exemptions are necessary or appropriate. Such exemptions would potentially lead to the exploitation of conflicts of interest, which could frustrate the achievement of the objectives of the Principles.

3.8

Question 3 – Notice Concerning Use of Expert Judgement: Should Administrators be required to briefly describe and publish with each benchmark assessment: (a)

a concise explanation, sufficient to facilitate a User’s or Market Authority’s ability to understand how the assessment was developed; terms referring to the pricing methodology should be included (e.g. spread-based, interpolated/extrapolated or estimate-based); and

(b)

a concise explanation of the extent to which the basis upon which judgement (i.e. exclusions of data which otherwise conformed to the requirements of the relevant methodology for that assessment, basing assessments on spreads, interpolation/extrapolation or estimates, or weighting bids or offers higher than concluded transactions etc), if any, was used in establishing an assessment. 5

3.9

These questions appear to be based on a misconception that, in relation to submissionbased benchmarks, the benchmark administrator will be the entity that is exercising Expert Judgement in the determination of the benchmark on a day-to-day basis. That is not the case.

3.10

Instead, Expert Judgement will be exercised by benchmark submitters (e.g. in the case of LIBOR, the panel banks that submit inputs to the benchmark administrator will often need to exercise Expert Judgement in determining their individual submissions). In doing so, benchmark submitters will be required to satisfy the requirements of the code of conduct established by the benchmark administrator and, where benchmark submission is a regulated activity, they will also need to comply with the rules governing such activity which are promulgated by the relevant regulatory authority (e.g. the UK Financial Conduct Authority in the case of LIBOR) 7.

3.11

The functions of the benchmark administrator, on the other hand, are to establish and maintain the benchmark methodology, to issue a code of conduct governing the role of benchmark submitters (including their use of Expert Judgement), to check submissions for manifest errors, to calculate and publish the benchmark, to oversee the application of the methodology and the code of conduct, to carry out statistical analyses of benchmark submissions in order to identify any irregularities, and to report any potentially abusive activity to the relevant regulatory authority. These functions do not involve the application of “Expert Judgement” by the benchmark administrator.

3.12

In view of these arrangements, the definition of “Expert Judgement” needs to be amended (please see the answer to Question 4 below). Moreover, as the term “Expert Judgement” is used in a number of the Principles, their drafting should be reviewed and consequential changes should be made.

3.13

In relation to the suggestion that a notice be published by the benchmark administrator alongside each benchmark assessment, this would be impractical (for the reasons described in paragraphs 3.9-3.11) and disproportionate. Instead, NYSE Euronext suggests that the benchmark administrator should ensure that the permissible use of Expert Judgement by benchmark submitters is clearly stated in the benchmark methodology and/or the code of conduct for submitters. Both of those documents should be published in order that market users and the public are properly informed about the basis on which the benchmark is determined.

3.14

Question 4 – Revision to the Principles: Please provide any suggested changes to specific principles or definitions of key terms set out in Annex A, including drafting proposals and rationale.

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The FCA’s rules stipulate that a benchmark submitter must ensure that its submissions are determined using an effective methodology which is based on the application of objective criteria and the use of relevant information. Furthermore, paragraph 8.2.6G of the FCA’s Market Conduct Sourcebook states that “An effective methodology for determining benchmark submissions in addition to quantitative criteria may include the use of qualitative criteria, such as the expert judgement of the benchmark submitter” (emphasis added).

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3.15

NYSE Euronext broadly agrees with the drafting of the Principles. However, it believes that the following amendments are necessary: (a)

Definition of Benchmark: under the definition as currently drafted, the price of an individual financial instrument would be classified as a “Benchmark”. The corollary of this is that each Regulated Market and Exchange would be classified by the Principles as a “Benchmark Administrator” simply by virtue of its operation of a trading system through which the price of such financial instrument is determined. NYSE Euronext recommends that the Principles be amended to make it clear that this is not the intention. This could be achieved either by stating that the price of an individual financial instrument is not to be regarded as a Benchmark, or by stating explicitly that Regulated Markets and Exchanges acting in their capacity as such will not be treated as if they were Benchmark Administrators.

(b)

Data Sufficiency (Principle 7): paragraphs (a) and (b) of Principle 7 require that benchmarks “be based on prices, rates, indices or values that have been formed by the competitive forces of supply and demand in order to provide confidence that the price discovery system is reliable”; and “be anchored by observable transactions entered into at arm’s length between buyers and sellers”. However, in circumstances where the underlying activity is itself a regulated activity 8, it should not be the responsibility of the benchmark administrator to ensure that the relevant underlying “price discovery process is reliable” or that transactions have been entered into “at arm’s length”. Instead, those are existing responsibilities of the relevant market and regulatory authorities, and they should not be duplicated by benchmark administrators. NYSE Euronext believes that this should be specified in Principle 7. Moreover, as currently drafted the Principle on Data Sufficiency does not adequately reflect the design and construction of submission-based benchmarks. Benchmark design and construction is, to a certain extent, a function of the characteristics and operation of the underlying market. As a result, for certain underlying markets a benchmark will be a more accurate reflection of that market if it is based on polled rates, e.g. because liquidity is diffuse rather than being concentrated, and transactions are sporadic rather than continuous. For example, EURIBOR is a complex of 15 rates with maturities ranging from one week to 12 months. At any one time a maturity within that complex will be more active or less active relative to the other maturities depending on a number of factors, including general economic and financial conditions, overall perceptions of creditworthiness and liquidity needs. It is unlikely that all maturities will experience periods of high activity simultaneously and, over time, it can be expected that the focus of activity will move between different points on the maturity curve. As a

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E.g. the operation of a stock exchange, and contributing to LIBOR, each of which is a regulated activity in the relevant jurisdiction and is subject to the authorisation and supervision requirements of the relevant regulatory authorities.

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result, rates for some (i.e. currently inactive or less active) maturities will need to be calculated and judged by reference to their relationship with other (i.e. currently more active) maturities in order for the theoretical pricing of the entire complex to be constructed and maintained. These considerations are not adequately reflected in the Principle on Data Sufficiency as it is currently drafted. In light of the issues raised in this section of the paper, NYSE Euronext suggests that the Principle be amended as follows: “The data used to construct a Benchmark determination should be sufficient to represent accurately and reliably the Interest measured by the Benchmark and should: (a) Be based on, or determined or corroborated with reference to, prices, rates, indices or values that have been formed by the competitive forces of supply and demand in order to provide confidence that the price discovery system is reliable; and (b) Be anchored by observable transactions entered into at that are arm’s Arm’s length transactions between buyers and sellers in the market for the Interest the Benchmark measures in order for it to function as a credible indicator of prices, rates, indices or values. For the avoidance of doubt, in circumstances where the underlying activity is a regulated activity (such as the operation of a stock exchange or making LIBOR submissions), it is not the responsibility of the Benchmark Administrator to ensure that the relevant price discovery process is reliable or that the relevant transactions are Arm’s length transactions. Administrators Submitters may rely on non-transactional data such as offers and bids and adjustments based on Expert Judgement for the purposes of determining their submissions to a Benchmark Administrator constructing an individual Benchmark determination, but provided such data and Expert Judgement should only be are used as an adjunct or supplement to in conjunction with transactional data. The principle does not prohibit the use of nontransactional data for indices that are not designed to represent transactions and where the nature of the index is such that nontransactional data is used to reflect what the index is designed to measure. For example, certain volatility indices, which are designed to measure the expected volatility of an index of securities transactions, rely on non-transactional data, but the data is derived 8

from and thus anchored in an actual functioning securities or options market.” (c)

Definition of “Expert Judgement”: as explained in the answer to Question 3, “Expert Judgement” is exercised by benchmark submitters, not the benchmark administrator. As such, NYSE Euronext suggests that the definition of “Expert Judgement” be amended as follows: “Expert Judgement: Refers to the exercise of discretion by an Administrator a Submitter with respect to the use of data in determining its Submissions to a Benchmark. Expert Judgement includes extrapolating values from prior or related transactions, adjusting values for factors that might influence the quality of data such as market events or impairment of a buyer or seller’s credit quality, or weighting firm bids or offers greater than a particular concluded transaction.”

(d )

Definition of “Submitter”: As explained in the answer to Question 1 - and notwithstanding the fact that stock exchanges fall outside the concept of a submitter to a benchmark - as currently defined “Submitter” would include the stock exchanges from which the administrator of an equity index takes price inputs. NYSE Euronext suggests that the definition be amended as follows: “Submitter: A legal person providing information (excluding information from a Regulated Market or Exchange concerning prices established in such venue) to an Administrator or Calculation Agent required in connection with the determination of a Benchmark.

3.16

Question 5 – Are any other principles needed: Should principles to address any additional issues, risks or conflicts of interest be developed? Please provide a summary of the issue and drafting for the proposed principle.

3.17

No, NYSE Euronext believes that the Principles are comprehensive as they stand.

4.

Next Steps

4.1

NYSE Euronext would welcome the opportunity to discuss the contents of its response to the Consultation Report with IOSCO, particularly if IOSCO requires any clarification about the contents of this response. The relevant contact details are set out in section 5.

4.2

NYSE Euronext is content for its response to the Consultation Report to be made public.

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5.

Contact Information

5.1

If IOSCO would like to discuss any of the points made in this response it should contact: Laurence Walton Director of Regulatory Policy European Government Affairs and Public Advocacy NYSE Euronext t: +44 (0)20 7379 2782 e: [email protected]

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