IOSCO publishes use of financial benchmarks for appropriate pricing, risk allocation

The Board of International Organization of Securities Commissions (IOSCO) Friday published a statement setting out matters for users of financial benchmarks (benchmarks) to consider in selecting an appropriate benchmark, which include considerations of appropriateness and contingency planning, particularly for scenarios in which a benchmark is no longer available.

The IOSCO said the objective of the statement is to enhance pricing and allocation of capital and risk, adding that raising awareness on the proper use of benchmarks as set out in the statement plays an important role in embedding sound benchmark practice in the financial system.

“Benchmarks play a key role in the financial system’s core functions of pricing and allocating capital and risk. They impact enormous volumes of credit products (including loans, mortgages, structured products, short-term money market instruments and fixed income products) and derivatives and have other uses,” it said.

IOSCO had earlier published the Principles for Financial Benchmarks in July 2013, which addressed conflicts of interest in benchmark-setting processes, as well as other matters related to benchmarks.

Its previous work focused on the responsibilities of administrators of benchmarks and submitters to benchmarks. The statement, in contrast, is directed at users of benchmarks. Users are encouraged to consider the matters covered by the statement, as appropriate.

The Board stressed however stressed that the current statement does not supersede existing laws, regulations, guidance or standards or relevant regulatory or supervisory frameworks in specific jurisdictions, including any IOSCO principles or undertakings agreed with regulators relating to a specific type of benchmark or related action. Rather, the statement is intended to help inform benchmark users and to complement existing IOSCO principles.

“The statement sets out matters for users of benchmarks to consider. These fall into two overarching categories. 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 read in parts.

The statement specifically recognises 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, and that 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.”

On consideration of appropriateness IOSCO said it is important that users select a benchmark appropriate for their own current and future needs, as well as (where applicable) those of their clients.

“Users are encouraged to consider how well a particular benchmark meets their own and their clients’ needs or hedging strategies. Information published or made available by the administrators in line with the Principles is likely to be useful for this purpose. Benchmarks can serve a valuable role when they are used appropriately. For example, a benchmark may be useful to manage financial risks efficiently,” it said.

On contingency planning, it noted that various factors, including external factors beyond the control of an administrator of a benchmark, might result in material changes to, or cessation of, the benchmark, including where an administrator is no longer able to determine a reference rate or other figure for whatever reason.

“Such a change or cessation of a benchmark could involve factors including, but not limited to, changes to market structure or product definition, any other condition which makes the benchmark no longer representative of its intended function or a situation relating to the financial creditworthiness or operation of the administrator,” it stressed.

It therefore urged users to consider their contingency plans in the event a benchmark is no longer available or materially changes in order to mitigate the potential risks involved. Users are encouraged to produce and maintain clear, comprehensive and robust written policies and procedures on actions they would take in such an event.

The IOSCO Principles were endorsed by the Financial Stability Board (FSB) and G20 Leaders at the St Petersburg Summit in September 2013 as global standards.

They have been used as guidance by benchmark administrators and financial regulators. In addition, based on the findings of an implementation review in 2014-2015, IOSCO published high-level guidance on how administrators of benchmarks should frame their annual statements of compliance with the Principles.