A European watchdog in Paris is going to snatch regulatory control of Libor from the British — or so the European Commission is proposing. It is the stuff of nightmares for the UK Treasury. The political land-grab is the most striking element of a broader shake-up to restore faith in the largely unregulated and, in some cases, shockingly amateur business of compiling benchmarks for everything from heating oil and coal to mortgage rates.
What is the Commission up to? The crux of the draft proposal, which we obtained and wrote about in today’s paper, is ending self-regulation for thousands of indices. All benchmarks must be authorised by a regulator, but there is a sliding scale of regulatory intrusiveness. In the naughty corner are Libor and Euribor, inter-bank lending benchmarks deemed important enough to require direct supervision by the European Securities and Markets Authority, an EU watchdog in Paris. Brussels argues the users, contributors and fallout from problems are EU-wide, so therefore deserve EU oversight.
Is this a bit heavily handed? The stakes are high. The benchmark industry generates around €2bn in revenue but the Commission estimates the size of related markets approach €1,000,000bn. Given many benchmarks have never been touched by law, there is a risk that the voluntary contributors may simply decide the legal risks aren’t worth it. When it comes to Euribor and Libor, the Commission’s answer is to give Esma powers to compel banks to submit transaction data or complete questionnaires on prices or bids. But contributions to the less important benchmarks won’t be mandatory.
Hadn’t these benchmarks already been reformed? Global regulators have launched a big clean up in the wake of the Libor scandal. While its rules to tighten governance go further than expected, the Commission vision, especially when it comes to methodologies, is largely aligned with the guidance from Iosco, the umbrella group of financial regulators. So for instance, Michel Barnier, the EU commissioner in charge of the proposal, stops short of requiring benchmarks to be based purely on transactions and allows a hybrid methodology where necessary, which uses survey results to estimate prices. The UK, of course, also launched its own big Libor reform project led by Martin Wheatley, the UK financial regulator. The Commission sides with most of his substantial findings but decides it should all be overseen from Esma in Paris rather than London.
Could they have done more to annoy London? Probably not, at least in terms of the governance. The Treasury will see this as another Brussels masterplan to centralise power and will probably rue the decision not to sue when Esma was made regulator for credit rating agencies (they almost did to show this went beyond the EU treaties). The real sting though will be the fact that it comes so soon after the UK’s own clean-up. What does it say about the Commission’s faith in the proud UK regulators? On top of that, the Commission opted for the European financial watchdog in Paris to do the job, rather than the European Banking Authority in London, which was at least politically a bit more palatable. For now though the official response from London is relaxed; they are confident of their arguments, have shown they are able to reform Libor, know this isn’t a London problem and not too worried about the power all going to Paris.
Does Brussels have the power to do this? Will it be passed? This is only a draft proposal; it still needs to be approved by the college of EU commissioners, a majority of member states and the European parliament. The Commission opted for a single market legal base, meaning the UK can be outvoted by a weighted majority of EU member states. There are plenty of countries that balk at giving pan-EU supervisors more powers at the expense of their national regulators. But as Britain’s defeat over the banker bonus cap showed, being outvoted is not impossible. The saving grace for London is probably the legislative timetable. There are a lot — around 25 — pieces of legislation to pass before the European elections next year (which effectively must be done by March). The benchmarks plan is near the back the queue. The odds are against it passing anytime soon, certainly in its most ambitious form. The risk of putting out such an ambitious proposal is that the laws will be delayed and vulnerable benchmarks will remain vulnerable, especially if contributors decide the legal risks aren’t worth it.
Will Libor really be run by the French? What powers will Esma have? Esma is based in Paris but it is a EU watchdog that presently is run mainly by non-French top staff. Under the proposal it is given serious clout. It can raid premises, seize documents, take recordings of phone calls, halt trading in instruments linked to faulty bechmarks, set legally binding codes of conduct, set questions for Libor and dictate the timing of surveys, mandate contributions, remove authorisation of an administrator, levy fees to administrators of benchmarks. Last of all, it can levy fines of up to 20 per cent of turnover on administrators, or more if the profits from the wrongdoing exceed that.
Does this really cover all benchmarks and indices? Aren’t there around 3,000 of them? Yes. No benchmark referenced in a financial contract or instrument is left out. It covers all benchmark providers and regulated contributors based within the EU. But there is a big caveat. The Commission gives itself the power to decide how the rules should be applied “proportionally”, so that an obscure prices for polymers are not treated in the same way as Libor or Euribor.
That hollows out the proposal a bit doesn’t it? The Commission does skip over a lot of the tricky details and leaves it to secondary technical rules — decided by the Commission. There are so-called “delegated acts” clarifying the legally binding code of conducts for benchmark contributors, exemptions for central bank run benchmarks, methodologies, terms of data suuply agreements from exchanges, governance, conflicts of interest, definitions of critical benchmarks, oversight rules — the list goes on. The Commission likes delegated acts.
Will Esma cover all these benchmarks? Aren’t there more benchmarks than Esma staff? Esma is the top supervisor, but it would only directly supervise those interest rate benchmarks deemed “critical”. All others are left to national regulators, who have to authorise an administrator for each benchmark and ensure there rules and procedures are robust. Commodity indices — like heating oil or gas — are not deemed critical.
Esma will be on a hiring spree. Where can I apply? Don’t raise your hopes. For the direct supervision of Libor and Euribor they will apparently be given just six new staff, five temporary staff and one seconded expert from a member state. It looks like they may need a few interns.