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European Commission
Rue de la Loi/Wetstraat 200
1049 - Brussels
Belgium
London, 29 November 2012
Consultation Document on the Regulation of Indices – A Possible Framework
for the Regulation of the Production and Use of Indices serving as Benchmarks
in Financial and other Contracts
Dear Sirs,
BlackRock welcomes the opportunity to respond to the European Commission
consultation on the regulation of indices.
BlackRock is a leader in investment management, risk management and advisory
services for institutional and retail clients worldwide. As of 30 September 2012,
BlackRock’s assets under management totalled $3.67 trillion (€2.88 trillion) across
equity, fixed income, cash management, alternative investment and multi-investment
and advisory strategies including the iShares® exchange traded funds (“ETFs”).
Through BlackRock Solutions®, the firm also offers risk management, strategic
advisory and enterprise investment system services to a broad base of clients,
including governments and multi-lateral agencies.
In Europe specifically, BlackRock has a pan-European client base serviced from
close to 20 offices across the continent. Public sector and multi-employer pension
plans, insurance companies, third-party distributors and mutual funds, endowments,
foundations, charities, corporations, official institutions, banks and individuals invest
with BlackRock.
We have summarised our views below that we develop further in our attached
response.
BlackRock does not produce or contribute to either rates or indices. However, we use
an extensive list of rate benchmarks and market indices in managing portfolios on
behalf of our clients. BlackRock has an “index” business in which we construct and
manage portfolios that are designed to track market indices. In managing client
assets, we use both publicly available rate benchmarks such as LIBOR, EURIBOR,
EONIA, SONIA, the Overnight Index Swap (‘OIS’) and privately owned market
indices such as MSCI, FTSE, Russell, S&P/Dow Jones, STOXX, Markit iBoxx,
Barclays, S&P/Dow Jones GSCI and DJ-UBS. In the case of the privately owned
market indices, we license these benchmarks from the relevant index provider.
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BlackRock strongly believes that it is important to differentiate between benchmarks
such as LIBOR and EURIBOR which are currently based on subjective estimates (for
the purposes of this note, we shall refer to these as ‘rate benchmarks’) and indices
which are either wholly (equity and commodity futures) or largely (fixed income)
based on financial transactions (for the purposes of this note, we shall refer to these
as ‘market indices’). We believe that they demand very different regulatory
approaches.
We recommend that the regulatory priority should be on the reform of rate
benchmarks such as LIBOR and EURIBOR to restore their market credibility. Such
rate benchmarks form the foundation of the interest rate swaps and Eurodollar
markets and remain a key reference rate for floating rate loans. As an investment
manager, we use rate benchmarks in three main ways: as a purely indicative
reference rate to calibrate the expected performance of a fund; as an explicit
reference rate used to determine the coupon paid on a security of a fund; and to
calculate coupon payments on a wide variety of medium to long dated interest rate
derivatives with a floating leg.
We support the following reform objectives for rate benchmarks such as LIBOR and
EURIBOR: focusing on the shorter tenors and the maturities most representative of
bank funding activity; augmenting subjective submission data with the use of
transaction data (with private reporting, time lags and/or aggregation as appropriate);
and strengthening their regulatory oversight coupled with sanctions under the Market
Abuse Regulation.
At the same time, a “one size fits all” for rate benchmarks such as LIBOR or
EURIBOR may no longer be the optimal solution. The reform agenda should,
therefore, include an explicit objective to allow market evolution to other benchmarks
such as the OIS, GCF Repo Index, Eurodollars futures market and EONIA. As
different investors and different borrowers have different needs and preferences, this
is likely to lead to multiple solutions with those benchmarks providing the greatest
liquidity gaining the greatest traction. For these reasons, we do not believe that it is
appropriate to mandate an alternative benchmark to replace LIBOR or EURIBOR or
that those particular rate benchmarks should be mandated for specific activities.
BlackRock uses market indices in its “index” and ETF businesses in which we
construct and manage portfolios that are designed to track market indices (so-called
“passive investments”). In doing so, we use an extensive list of index providers for
the calculation of market indices. We do not contribute any data to such market
indices but determine their efficacy by measuring them against a number of key
criteria such as whether the index is representative of its opportunity set, is
‘investable’, transparent and sufficiently diversified (taking into account, in all cases,
any applicable regulatory requirements in respect of such market indices).
BlackRock and its clients have extensive choice in the selection of an index provider
and key metrics help to determine the best provider for a particular product. The
ability to substitute one market index for another ensures a competitive and
innovative marketplace. BlackRock takes an active interest in the construction of
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indices and provides feedback through index consultations and on index committees,
where applicable. In addition, while BlackRock is not in a position to verify the
construction or accuracy of an index (nor guarantee that a chosen index will be
appropriate for any given investor), BlackRock carries out certain validation exercises
in respect of the market data used to construct indices and closely monitors index
turnover as part of the daily portfolio management process to the extent reasonably
possible.
BlackRock supports the inclusion of market indices in the market abuse regime and
acknowledges that further regulation of market indices is also an option. However, as
market index providers are not currently regulated, we anticipate that the introduction
of a new regulatory regime would result in additional cost for providers which would
ultimately be passed onto the end investor. As such, we consider that the benefits of
any proposed regulation need to be carefully considered and weighed against any
negative impacts. In our view, it may be more appropriate to address potential risks
associated with market indices (for example, losses that investors may suffer where
there is an error in the relevant index and/or as a result of extraordinary rebalances
required in connection therewith) through enhanced risk disclosures and investor
education. Finally, because of competition and innovation in the marketplace, index
providers will be incentivised through market forces to ensure their products are of a
certain quality and viable indices for the end investor.
****
We attach our more detailed responses to the individual questions posed in the
Consultation. We are prepared to assist the European Commission in any way we
can, and welcome continued dialogue on these important issues. Please contact any
of the undersigned if you have comments or questions regarding BlackRock’s views.
Yours faithfully,
Joanna Cound
Managing Director,
Head of EMEA Government Affairs
& Public Policy
BlackRock
+44 (0)20 7743 5579
[email protected]
12 Throgmorton Avenue
London, EC2N 2DL
United Kingdom
James DesMarais
Managing Director,
General Counsel, EMEA
Legal & Compliance
BlackRock
+44 (0)20 7743 4805
james@[email protected]
12 Throgmorton Avenue
London, EC2N 2DL
United Kingdom
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Detailed response to the European Commission Consultation on the
Regulation of Indices – A Possible Framework for the Regulation of the
Production and Use of Indices serving as Benchmarks in Financial and other
Contracts
Chapter 1. Indices and Benchmarks: What they are, who produces them and for
which purposes
(1) Which benchmarks does your organisation produce or contribute data to?
BlackRock does not directly produce or contribute to either rate benchmarks or
market indices.
(2) Which benchmarks does your organization use? What do you use each of
these benchmarks for? Has your organization adopted different benchmarks
recently and if so why?
BlackRock uses a wide range of rate indices including LIBOR and EURIBOR in a
variety of currencies and tenors, EONIA, SONIA and the Overnight Index Swap
(‘OIS’). A significant proportion of the investment portfolios we manage use LIBOR or
EURIBOR as implicit or explicit reference rates. Further information on their use is
given in our responses to Questions 4 and 5. However, we started to make greater
use of the OIS benchmark after the financial crisis as more interest rate swaps
became collateralised by cash (and hence the credit risk of cash flows should reflect
the risk free rate rather than rates derived from LIBOR).
We also expect the Eurodollars futures rate and the DTCC GCF Repo Index rate to
attract greater use in the future. The Eurodollar futures market has developed into a
robust, deep and liquid market which is transparent and based on transactions.
LIBOR rates for longer maturities can be extracted from this market, obviating the
need for LIBOR “fixings” for these longer maturities. The GCF Repo Index is the
weighted average of the interest rates paid each day on General Collateral Finance
Repurchase Agreements based on US Government securities. It has a high daily
volume of interdealer trading of tripartite repo and it mirrors bank to bank
transactions.
BlackRock’s index and ETF businesses construct and manage portfolios that are
designed to track market indices. We license benchmark data from many index
providers, including MSCI, FTSE, Russell, S&P/Dow Jones, STOXX, Markit iBoxx
and Barclays and are continually assessing and adopting new benchmarks. This is
largely driven by client-specific requirements, innovation, and incremental
improvements made by the providers in the construction of equity indices.
(3) Have you recently launched a new benchmark or discontinued existing
ones?
As stated in our response to Question 1, BlackRock itself does not publish or
generate rate benchmarks or market indices. Our index and ETF businesses are,
however, continuously using new indices as benchmarks in response to the demands
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of our client base. In contrast, fewer alternatives exist for our legacy products that
reference rate benchmarks such as LIBOR. We have started to use the OIS
benchmark. The GCF Repo Index was only introduced in July 2012 and hence its
derivative term structure is still quite young. The scale of adoption of alternative rate
benchmarks will also depend on their liquidity.
(4) How many contracts are referenced to benchmarks in your sector? Which
persons or entities use these contracts? And for which purposes?
We do not consider that the number of contracts provides a meaningful indication of
the significance of index usage. As an asset manager, we estimate that the vast
majority of our funds either track rate benchmarks or market indices directly or use
such rate benchmarks or market indices as a reference in some manner.
Clients use rate benchmarks such as LIBOR and EURIBOR largely as a proxy for a
generic low risk alternative investment to be able to make fair comparisons across
different investment opportunities. Such clients tend to be at the conservative end of
the spectrum and include client segments such as corporate treasurers, pension
funds, insurance companies and private clients. Other clients use such rate
benchmarks to calculate performance over cash rates.
The potential uses of market indices are extensive and varied. Institutional long term
investors are increasingly turning to index funds to represent the core of their
portfolios.
(5) To what extent are these benchmarks used to price financial instruments?
Please provide a list of benchmarks which are used for pricing financial
instruments and if possible estimates of the notional value of financial
instruments referenced to them.
Benchmarks such as LIBOR and EURIBOR are used extensively as explicit
reference rates to determine the coupon paid on a security or interest rate
derivatives. As such, LIBOR and EURIBOR are of prime importance to pension
funds, money market funds and short term bond funds. Pension funds following
liability driven investment (LDI) strategies typically use interest rate swaps with
maturities of up to 40 or 50 years. Such pension funds represent over 50% of the UK
and 90% of the Dutch pension fund market. Money market funds are exposed to
LIBOR in two ways: instruments with LIBOR maturities can represent up to 30% of
the portfolio; and custodians typically use LIBOR as a pricing tool for European
commercial paper, floating rate notes and certificates of deposit.
(6) How are benchmarks in your sector set? Are they based on real
transactions, offered rates or quotes, tradable prices, panel submissions,
samples? Please provide a description of the benchmark setting methodology.
The methodology ranges from benchmarks such as LIBOR and EURIBOR (the
benchmark setting process of which is described in the Consultation) to equity
indices where the data comes from stock exchanges and data providers such as
Bloomberg and which are calculated based on real transactions completed at a
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particular point in the trading day. Commodity futures indices tend to use actual
prices, quantities and data which may be considered objective and verifiable. The
data typically comes from commodity futures exchanges and from national and
supranational organisations responsible for producing fundamental data on
commodity markets (in particular world production quantities used for index
weightings). Fixed income indices differ in that no single price discovery process
exists. As fixed income instruments trade over-the-counter (“OTC”), the same bond
can therefore have different prices in different index providers’ indices. In addition,
some fixed income instruments can trade very infrequently or by appointment only. In
such cases, indicative or model derived prices may be used in the relevant indices.
For further information please refer to our response to Question 8.
(7) What factors do you consider to be the most important in choosing a
reliable benchmark? Could you provide examples of benchmarks which
incorporate these factors?
It should be noted that BlackRock cannot guarantee that a chosen benchmark will be
appropriate for a given investor and cannot guarantee the quality or accuracy of a
benchmark (including whether such benchmark is reliable). That said, BlackRock
employs certain techniques and takes into account certain considerations to help
identify benchmarks which may be appropriate for the relevant objective.
At the most simplistic level, BlackRock undertakes commercially reasonable
endeavours to determine whether a benchmark is representative, can be replicated,
measured, has appropriate transparency and governance and is sufficiently liquid.
For rate benchmarks, such as LIBOR, the single most important precondition for
adoption by the market is liquidity. For our index businesses, we use commercially
reasonable endeavours to determine the efficacy of a benchmark by considering its
performance against a number of key criteria. If a benchmark does not meet these
criteria, it will struggle to gain acceptance in the market. The key questions we ask
are:
 Is the benchmark representative of the target opportunity set?
 Is the benchmark sufficiently diversified and reflective of the
country/region/sector that is the target of a client’s index equity investment?
 Is the benchmark constructed using market capitalisation weights or an
alternative methodology?
We further test potential indices against the following questions before determining
whether they may be acceptable for use.
 Are real life investment constraints incorporated into the calculation of the
benchmark to make it investable?
o Are foreign investor limits incorporated into the free float calculation
of a stock?
o Are strategic holdings incorporated into the free float calculation of a
stock?
o Are market liquidity screens incorporated?
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

o Can foreign investors gain access to an equity market?
Are the rules governing index calculation sufficiently transparent?
o Are the index calculations clear and replicable?
o Is the process of adding and removing stocks clear and based on
clear, pre-determined criteria?
o Is the treatment of corporate events based on clear, pre-determined
criteria?
o Are free float changes incorporated based on clear rules and data
available to the marketplace?
Other factors
o What is the level of annual turnover for the index?
o How reliable is the data that is delivered by the index provider?
o Does the index have investor acceptance and what are the reasons
for that acceptance?
Chapter 2. Calculation of Benchmarks: Governance and Transparency.
(8) What kinds of data are used for the construction of the main indices used in
your sector? Which benchmarks use actual data and which use a mixture of
actual and estimated data?
Benchmarks such as LIBOR and EURIBOR are currently based on estimations. In
contrast, the OIS and GCF Repo Index use transactional data. Whilst the daily fix for
OIS is based on actual transactions, the term structure is based on a market
snapshot of indicative quotes at any given time; whilst there are a reasonable
number of OIS transactions every day, these are currently not centrally reported and
are biased towards shorter tenors in more liquid currencies. The term structure for
the GCF Repo Index is relatively young as the benchmark was only recently
launched. Whilst current regulatory initiatives will improve transparency around
transaction reporting, this will not address the fact that these trades are not
contemporaneous and not every tenor in every currency will trade every day.
Equity indices are calculated based on real transactions completed at a particular
point in the trading day: generally the closing pricing mechanism of a given
exchange. In addition to stock prices, equity indices must incorporate the number of
shares and free float in order to calculate market values and weights for each asset.
These can then be aggregated to calculate the index level.
Fixed income indices can be based on real transaction data as well as modelled or
estimate prices. The latter is a reflection of the fact that many fixed income assets do
not trade daily. Modelled and estimate prices are used to avoid out of date prices.
Data for commodity futures indices typically comes from commodity futures
exchanges and from national and supranational organisations responsible for
producing fundamental data on commodity markets (in particular world production
quantities used for index weightings).
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(9) Do you consider that indices that do not use actual data have particular
informational or other advantages over indices based on actual data?
BlackRock considers that, for rate benchmarks such as LIBOR and EURIBOR, a
mixed or hybrid methodology for calculating benchmarks is more likely to restore
market confidence than the current methodology or one based solely on transactional
data.
Gary Gensler, Chairman of the US Commodity Futures Trading Commission
(“CFTC”), highlighted in the European Parliament Public Hearing on LIBOR (24
September 2012) the fact that LIBOR rates can be different to those of other
benchmarks and posed the question whether LIBOR should be reformed or replaced.
Chairman Gensler’s questions included “why is US Dollar LIBOR so different from
US Dollar EURIBOR?”, “why have LIBOR and other benchmark rates typically not
been aligned, since 2008, with the borrowing rates that would be implied by FX
markets?”, “why is the volatility of dollar denominated LIBOR so much lower than the
volatility of other dollar denominated short term interest rates?” and “why do the one
year borrowing rates that the majority of the panel banks submit to the BBA for
LIBOR not appear to fully incorporate the market rates for their credit risk as
indicated by the rates for the institution’s one year credit default swap?”
We outline below our brief response to these questions and would be pleased to
provide further data and discuss these issues in greater depth if appropriate. Our
conclusion remains that we should support the reform of LIBOR, specifically that
LIBOR should adopt a hybrid methodology, while encouraging the development of
alternative benchmarks.
We believe that the differences highlighted by Chairman Gensler reflect the fact that
LIBOR and EURIBOR each have a different selection of banks on their panels
coupled with recent stressed conditions in the funding markets. For example, banks
in the EURIBOR survey represent banks from the European Union countries which
typically lack significant sources of US dollar deposits. This raises their cost of
borrowing in dollars relative to banks that have significant dollar deposit taking
franchises. Additionally, because of this relative lack of access to dollar deposits,
Central Bank liquidity swap lines (also referred to as reciprocal currency
arrangements) were established amongst several Central Banks. Of most relevance
here are those swap lines established between the US Federal Reserve and the
European Central Bank (“ECB”). The European banking system can benefit from
access to dollar liquidity provided to the ECB through these facilities but that liquidity
comes at a cost. Initially, in the first phase of usage following 2008, the Federal
Reserve charged 100 basis points over the U.S. dollar overnight index swap rate.
Beginning with the 30 November 2011 extension of the program the rate was cut by
50 basis points. European banks accessing dollar funding through these sources
would register this additional cost of borrowing into their survey responses
accounting for the higher borrowing rates indicated in USD Euribor relative to USD
LIBOR. Hence, the EURIBOR US dollar rate is typically higher than that for LIBOR.
Similarly, the differences in LIBOR, EURIBOR and the currency swap markets reflect
the differences in the underlying composition of participating banks and their relative
dependencies on the wholesale funding markets.
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The relationship between one year borrowing rates indicated by panel members in
the LIBOR submissions and their one year Credit Default Swap (CDS) spreads is
affected by several factors, any of which can account for meaningful differences
between the two financial series.
First and foremost, the comparison suffers from a critical definitional difference: CDS
spreads represent the cost of obtaining protection from a counterparty on the default
of the reference entity while LIBOR rates reflect the remuneration for lending to the
reference entity dollars. These two are fundamentally different: the first isolates the
default risk of the reference entity while the later incorporates both the cost of interest
rates in the financial market and the risk of nonpayment (i.e. the credit risk of the
entity).
Second, particularly during the crisis and post crisis periods after 2008, longer dated
term funding market transaction volumes declined significantly. This led to greater
estimations and judgment likely being used to determine the LIBOR submissions as
real transaction data did not exist. Hence our recommendation that the matrices of
LIBOR maturity submissions be reduced to shorter tenors and to those tenors that
are both most frequently used as benchmarks and are most likely to have a greater
capacity to support transaction based submissions under the hybrid approach.
Third, the market for CDS for short tenors is impacted by several issues unique to
both credit and credit derivative markets: the general level of risk aversion leading to
imbalance in the supply of and the demand for credit protection; the unique demand
and differences in the supply of and demand for short dated versus longer dated
credit protection; and the level of credit risk in the financial system and the increase
in demand in particularly short tenor CDS as protection from “Jump to Default” risk.
All of these factors can contribute to meaningful differences between rates observed
in 1 year CDS versus 12M LIBOR submission rates.
BlackRock notes that this question is not applicable to market equity indices which
are only and properly calculated using actual market transactions.
(10) What do you consider are the advantages and disadvantages of using a
mixture of actual transaction data and other data in a tiered approach?
A number of reasons exist why a hybrid approach may be superior. Where the
underlying assets of a fixed income market index do not trade frequently, for
example, the modeled prices can provide a more accurate price valuation than the
last actual trade. In addition, transactional data without some measure of volume
may not provide an accurate indication of the amount that can be traded at a
particular price.
BlackRock also believes that a hybrid approach for rate benchmarks such as LIBOR
and EURIBOR, coupled with a reduction of the number of tenors and currencies, will
focus rates appropriately on those most representative of interbank funding and
those where most transactions are likely to take place. Together with auditing of
submissions and greater regulatory oversight, we believe that such a hybrid
approach is the most likely to restore investor confidence in such benchmarks and
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the least likely to cause unforeseen consequences for savers and pensioners. In
general, the more radical the change, the greater the impact on potential winners and
losers.
(11) What do you consider are the costs and benefits of using actual
transactions data for benchmarks in your sector? Please provide examples
and estimates.
Many benchmarks and indices use transactional data, typically market indices such
as equity and many fixed income indices. In the case of the index and ETF
businesses, the only significant cost incurred is for the market data provided by
exchanges.
Replacing benchmarks such as LIBOR and EURIBOR with benchmarks based purely
on transactional data will, in contrast, represent a significant change and incur
substantial costs which will inevitably be borne by the end investor. Many securities
use LIBOR and EURIBOR as an explicit reference rate to determine the coupon.
Moving the baseline to EONIA or SONIA, for example, would have implications for
the overall risk and return profile of the investment: a straight substitution of LIBOR +
300bp with EONIA + 300bp would in many cases be economically inequitable
resulting in the need to rebase the whole contract. Attempts to ‘fix’ the credit
component at a specific spread would not be an accurate reflection of how the
evaluation of credit risks evolves over time.
This issue around contractual change is accentuated by the long term nature of many
interest rate derivatives, typically 40 and 50 years for liability driven pension fund
strategies. Early termination of such contracts may result in potentially substantial
economic and liquidity impacts. A significant change in the value of swaps will
change, for example, the value of a pension fund’s assets, including its interest rate
swap positions, while its cash flow liabilities will remain unchanged. This would
impact the pension fund’s funding ratio and its ability to pay its liabilities, that is, the
pensions it is designed to pay.
(12) What specific transparency and governance arrangements are necessary
to ensure the integrity of benchmarks?
We set out our thoughts on transparency for indices in our response to Question 7.
Such a high degree of transparency to the market is, however, not appropriate, for
benchmarks such as LIBOR and EURIBOR. We recommend instead that raw
transaction data should be communicated with a modest time lag to regulators
ensuring that any material deviations be swiftly investigated. Commercial reasons
also exist to further delay or aggregate transaction data for public consumption.
BlackRock would support the inclusion of non-participating members on the oversight
committees of benchmarks such as LIBOR and EURIBOR.
(13) What are the advantages and disadvantages of imposing governance and
transparency requirements through regulation or self-regulation?
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BlackRock supports greater transparency and clear standards of governance as we
believe that both are fundamental to restore market confidence in rate benchmarks
such as LIBOR and EURIBOR. We would recommend a binding code of conduct,
subject to independent audit, coupled with sanctions as set out in the market abuse
regime. We note in this context that IOSCO has recommended self-regulation
principles for price reporting agency (“PRA”) benchmark governance (coupled with
an independent audit) but will apply regulation to PRAs should compliance be
unsatisfactory.
(14) What are the advantages and disadvantages of making contributing data
or estimates to produce benchmarks a regulated activity? Please provide your
arguments.
BlackRock believes that the market is best served by representative panels providing
a combination of subjective and transactional data which is subject to both
transparency and audit requirements. If the costs for contributing banks become too
great, they may decide to withdraw from participating in a panel and consequently
the panel becomes less representative. The decision centres around weighing up the
greater protection users may receive through regulation against the risk that
regulation could make the rate benchmark less representative. Greater regulatory
oversight (as suggested in the Wheatley Review) coupled with sanctions under the
Market Abuse Directive could achieve a reasonable balance as long as the regulation
is appropriately calibrated.
(15) Who in your sector submits data for inclusion in benchmarks? What are
the current eligibility requirements for benchmarks' contributors?
This question is not applicable for BlackRock.
(16) How should panels be chosen? Should safeguards be provided for the
selection of panel members, and if so which safeguards?
BlackRock believes that the principal safeguard is afforded by transparent
governance standards. These should include the seniority of panel members,
methodology and operations, a requirement to make public the panel’s performance
against the governance standards as well as consultation with end-users of the
relevant rate benchmark. BlackRock would also support the inclusion of nonparticipating members on oversight committees (not panels).
(17) How should surveys of data used in benchmarks be performed? What
safeguards are necessary to ensure the representativeness and integrity of
data gathered in this way?
BlackRock believes that volume metrics, the submission of raw data, the process for
validating and auditing submissions, transparent governance and a framework for
managing conflicts of interest are all critical in ensuring the representativeness and
integrity of the data gathering.
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(18) What are the advantages and disadvantages of large panels? Even in the
case of large panels could one panel member influence the benchmark?
BlackRock prefers larger (voluntary) panels over smaller panels precisely because
larger panels reduce the likelihood that any individual submission can impact the rate,
particularly when it is calculated by the “trimmed mean” methodology. A move from
the mean to the median might reduce further the potential for such an impact. We
note however that the difference between the mean and the median in US Dollar 3
month LIBOR since the beginning of 2011 is modest. The average difference was
0.14 bps with the median being higher (taking the median on the trimmed panel).
(19) What would be the main advantages and disadvantages to auditing of
panels? Please provide examples.
The main advantage of auditing panels is the greater security and confidence it gives
to market participants about the benchmark. Panel members may have concerns that
sensitive data might inappropriately become public as a result of the audit process
and at the cost of carrying out regular audits.
We note that withdrawals from panels have taken place where banks see limited
benefits and unknown costs.
(20) Where indices rely on voluntary contributions, do you consider that there
are factors which may discourage the making of these contributions and if so
why?
A number of factors might discourage banks from contributing to voluntary panels,
including the level of regulation, reputational risk, additional costs (do they pay for
their own audits?) and potentially sensitive data becoming public.
(21) What do you consider to be the advantages and disadvantages of
mandatory reporting of data? Please provide examples.
Mandatory participation could result in large panels. The benefit which one would
expect from a large panel could, however, be undermined by mandatory participation
if this means that the panel becomes unrepresentative or if it creates uncertainty in
the construction of the panel. Who, under a mandatory system, would have
responsibility for defining the criteria to select the banks that must contribute? Who
would monitor and maintain the criteria and hence the banks selected? Any
benchmark should reflect ‘volume weighting’ to some degree – an arithmetic mean
established from a very broad panel with a large number of marginal participants
could result in fixes which were not representative of the economically significant
activity.
(22) For entities contributing to benchmarks which are regulated by financial
regulation, what would be the advantages and disadvantages of bringing their
benchmark submissions under the scope of this framework?
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As previously stated, in respect of rate benchmarks, BlackRock would be supportive
of introduction of audit requirements, and the requirement that panels be
representative and of sufficient size to reduce the likelihood that an individual
member can influence a rate. Participation in the setting of rate benchmarks such as
LIBOR and EURIBOR is, however, voluntary whilst the benefits of a credible
benchmark accrue to all in the financial system. Changes in the rate setting process
need to take into account the impact on the voluntary nature of the rate setting
process. Any proposed reforms to such benchmarks should therefore weigh both the
benefits of the reform against direct and indirect costs in the form of the effect the
changes may have on dissuading participation.
(23) Do you consider that responsibility for making adjustments if inadequate
data is available should rest with the contributor of the data, the index provider
or the user of the index?
In respect of rate benchmarks, responsibility for benchmarks such as LIBOR should
generally lie with the contributor of the data, subject to appropriate regulation and
oversight. We acknowledge the role that those validating the submission of rates play
in highlighting material deviations between the rates submitted and the raw data
submitted and would encourage further measures to enhance the effectiveness of
this process.
This question is not applicable to equity indices.
(24) What is the formal process that you use to audit the submissions and
calculations?
While BlackRock is not in a position to verify the construction or accuracy of a market
index and assumes no liability in connection with any index errors or omissions, we
use commercially reasonable endeavours to conduct best practice due-diligence
exercises with our benchmark providers. These assist in delivering efficacy in
operational processes, calculations, data-delivery, quality control and error
resolution. In addition, we participate on advisory committees where relevant and
provide guidance in client consultations that the index providers undertake when
considering methodology changes.
(25) If there are any weaknesses identified in the audit, who are they reported
to and how are they addressed? Is there a follow up process in place?
Our due diligence exercises do not audit data but do assess operational processes
and controls. When deficiencies are discovered they are fed back to the index
provider along with BlackRock’s vendor management, index equity management,
and risk teams.
(26) How often are submissions audited, internally or externally, and by what
means? Do you consider the current audit controls are sufficient? What
additional validation procedures would you suggest?
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While we are not in a position to perform daily audit checks, our data integrity team
seeks to validate equity market prices every day to assist in ensuring that
discrepancies are appropriately managed and kept to a minimum. Any deviations so
identified are promptly investigated and escalated, where necessary. In addition, our
index research team analyses index changes as a daily process and queries
unexpected changes and variances with the index providers and portfolio managers.
For fixed income, we cannot validate prices as there is not a confirmed price to
compare against but we do check for any big variances in price and employ other
appropriate quality control measures. That said, in respect of both equity and fixed
income indices, where an index is being re-balanced, the index re-balance files will
often be issued at very short notice by the index provider with a tight turn-around for
the re-balancing trades. Where this occurs, it will limit the extent to which data can be
verified in practice.
Furthermore, it should be noted that, for passive funds which have the investment
objective of tracking a particular index, the investment manager is mandated to track
that index notwithstanding the fact that there may be latent errors, inaccuracies or
omissions in the index data itself.
In respect of market indices, we acknowledge that regulation of market indices may
be an option in enhancing validation procedures and minimising data-related issues.
However, as index providers are not currently regulated, we anticipate that the
introduction of any regulatory regime specifically targeted at index providers would
result in additional cost for such providers. We also suspect that such costs will
ultimately be passed onto the end investor (undermining the benefits of passive
investing, making such instruments uneconomical). As such, we recommend that the
impacts of any proposed regulation be carefully measured to weigh the advantages
against the disadvantages. On balance, we consider that it may be more appropriate
to address potential risks associated with market indices (for example, losses that
investors may suffer where there is an error in the relevant index and/or as a result of
extraordinary rebalances required in connection therewith) through enhanced risk
disclosures and investor education. We consider this in more detail in our response
to Question 29 below.
(27) What are the advantages and disadvantages of a validation procedure?
Please provide examples.
Once again, while BlackRock is not in a position to verify the construction or
accuracy of an index and assumes no liability in connection with any index errors or
omissions, we would be supportive of validation procedures which are designed to
mitigate incorrect data feeds into the portfolio management process. As a result, we
use commercially reasonable endeavours to validate equity price data and monitor
the changes to all indices tracked on a daily basis to ensure that any index turnover
is correct. Part of BlackRock’s index investment philosophy is to minimize costs to
funds by only transacting when necessary.
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That said, as above, in respect of both equity and fixed income market indices, where
an index is being re-balanced, the index re-balance files will often be issued at very
short notice by the index provider with a tight turn-around for the re-balancing trades.
Where this occurs, it will limit the extent to which data can be verified in practice.
(28) Who should have the responsibility for auditing contributed data, the index
provider or an independent auditor or supervisor?
In respect of market indices, index providers are responsible for performing and
calculating index data in accordance with the specified methodology. As it is a
competitive marketplace, the inability to deliver accurate equity indexing solutions will
render such index providers and the adoption of their indices as benchmarks less
attractive.
(29) What are the advantages and disadvantages of making benchmarks a
regulated activity? Please provide your arguments.
Please refer to our response to Question 14 for rates indices.
In respect of market indices, index calculation is a competitive marketplace and index
providers do consult with end-users on methodology changes and improvements.
Directly competing products can be substitutes for each other, giving end-users
options and the recourse to change providers if governance and transparency are
deemed to be insufficient. As we note above, in respect of index-tracking funds
(including ETFs) passive investing represents a low-cost and efficient means of
delivering the desired exposure to a wide variety of investors. Index funds
(particularly ETFs) can be simple, flexible, cost-effective and offer opportunities to
spread risk:

Lower costs – index funds can be less expensive than many traditional
pooled funds.

Spread risk – index funds provide diversification and reduce investment
concentration risks.

Transparency – ETFs, in particular, offer a high degree of transparency
regarding the ETF portfolio holdings, performance and costs.

Flexibility – there is a wide choice of index funds (and ETFs) available, and
ETFs can be bought and sold simply and quickly.
The wide range of index products available allows investors to build portfolios that
aim to fulfill many investment goals. The ability to simply and efficiently invest in
many different asset types, from stocks and shares, bonds, commodities, property is,
in such a way, accessible to investors.
Should regulation and/or audit requirements be imposed on index providers directly,
we have concerns that the costs of compliance in relation thereto would be passed
back onto the end investor in index products. As such, the introduction of such
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measures may render passive investing uneconomical, undermine the benefits set
out above and/or lead to a reduction in the choice of such products available.
As already noted, we would support alternative measures which focus on enhancing
disclosure requirements (ensuring that end investors understand the relevant risks of
index-tracking products), rather than the implementation of a regulatory regime
directly applicable to index providers, the costs of which are ultimately passed back
to the end investor. The alternative approach to regulation we set out above would
assist in ensuring that end investors understand the risks associated with indextracking products, while retaining access to, and a broad selection of, investments
with the benefits outlined above.
Finally, it should be noted that the use of market indices as benchmarks for indextracking funds is already regulated, to an extent, through the UCITS Directive and the
new ESMA Guidelines on ETFs and other UCITS issues. Such regulations provide,
inter alia, that a chosen market index for an index-tracking UCITS must be
representative of the relevant market and must be sufficiently diversified.
Chapter 3: The Purpose and Use of Benchmarks
(30) Is it possible and desirable to restrict the use of benchmarks? If so, how,
and what are the associated costs and benefits? Please provide estimates.
BlackRock does not believe that it is desirable to restrict the use of rate benchmarks
or market indices. Market participants should be allowed to select benchmarks or
indices that meet the needs of borrowers and lenders. Different investors and
different borrowers have different needs and preferences and these evolve over time.
We note that this question is not applicable to equity indices.
(31) Should specific benchmarks be used for particular activities? By whom?
Please provide examples.
We refer to our answer above.
(32) Should benchmarks developed for wholesale purposes be used in retail
contracts such as mortgages? How should non-financial benchmarks used in
financial contracts be controlled?
This depends on the individual circumstances. BlackRock would generally suggest
that any benchmark be chosen as ‘best fit for purpose’ to meet the relevant
investment objective. If a wholesale benchmark achieved the same objective for retail
purposes, there should be no reason to exclude it from retail contracts.
(33) Who should have the responsibility for ensuring that indices used as
benchmarks are fit for purpose, the provider, the user (firms issuing contracts
referenced to benchmarks), the trading venues or regulators?
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For rate benchmarks such as LIBOR and EURIBOR, the panel members and
regulator should have responsibility for ensuring that indices are fit for purpose. As
stated previously, the submission of data and administration of such indices should
be subject to greater regulatory oversight as set out in the Wheatley Review.
For market indices, we feel that it is the responsibility of the index providers to ensure
that their indices are designed and structured in such a way that they deliver the
return on their intended exposure. The assessment of whether something is “fit for
purpose” will depend on the individual circumstances (and it may be appropriate for
providers acting in an advisory and/or fiduciary function to assume a degree of
responsibility for such assessment).
In any case, all indices (rate benchmarks and market indices) should be subject to
the market abuse regime and we strongly support an enhanced transparency and
disclosure regime whereby investors are provided with sufficient information such
that they can make an assessment as to whether the relevant index is fit for purpose
to achieve their investment objective.
Chapter 4: Provision of Benchmarks by Private or Public Bodies
(34) Do you consider some or all indices to be public goods? Please state your
reasons?
We do not believe that indices, with the exception of those referred to in our
response to Question 37, are public goods. However, we support the European
Commission’s proposals to expand its provisions for market manipulation in the
Market Abuse Directive and initiatives aimed at achieving greater transparency and
regulatory oversight for benchmarks such as LIBOR and EURIBOR.
We note that significant investment and research is involved in creating and
calculating indices and it is a competitive market place with providers differentiating
through incremental improvements and innovation. As a result there exists
intellectual property within this space. We believe that end investors are better
served by existing market competition within the index sector than by a potentially
smaller subset of calculation agents.
(35) Which role do you think public institutions should play in governance and
provision of benchmarks?
For benchmarks such as LIBOR and EURIBOR, authorities should ensure that the
key participants involved in the establishment of benchmarks and fixing rates are
subject to broad regulatory oversight in relation to these activities. We are supportive
of greater regulatory oversight coupled with sanctions as set out under the Market
Abuse Regulation.
(36) What do you consider to be the advantages and disadvantages of the
provision of indices by public bodies?
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We believe that end investors are generally better served by competition between
market participants and their greater ability to respond to market conditions and
market liquidity.
(37) Which indices, if any, would be best provided by public bodies?
Public bodies are best placed to provide overnight deposit rates such as EONIA,
SONIA and FED Funds.
Chapter 5: Impact of Potential Regulation: Transition, Continuity and
International Issues.
(38) What conflicts of interest would arise in the provision of indices by public
bodies? What would be the best way of avoiding these conflicts of interest?
Conflicts of interest may arise in the provision of indices by public bodies. For this
reason, where public bodies provide benchmarks (e.g. gilt DMO closing prices), they
should only be used pari-passu with commercially-provided benchmarks.
(39) What are the likely transition challenges, costs and timelines for relevant
benchmarks? Please provide examples.
We outlined some of the challenges in our response to Question 11 and comment
here further on the costs and timelines.
Where benchmarks such as LIBOR and EURIBOR are used as a purely indicative
reference rate to calibrate the expected performance of a fund, without any
contractual or mathematical impact on the investors’ return, alternative indicative
reference rates could be established with minimal repercussions, provided that
sufficient time for contractual notification or renegotiation is allowed.
Where LIBOR and EURIBOR are used as an explicit reference rate, a move away
will be more problematic as there would be significant economic impacts of any
contractual shift, not least due to the implicit credit spread embedded in LIBOR. In
the case of money market funds, it might take two to three years to transition to
another benchmark and longer for short term bond funds.
This legacy impact is far more significant for pension funds following liability driven
investment strategies that invest in long dated interest rate derivatives (commonly up
to 40 and 50 years). Re-calibration of existing LIBOR and EURIBOR contracts, for
example, to a rate no-longer based on an interbank unsecured lending rate would
represent a significant challenge and could potentially lead to greater dislocation and
disruption than any distortion of LIBOR and EURIBOR that may have occurred over
the past few years.
Finally, we note that LIBOR and EURIBOR are contractually embedded in a number
of financial instruments; replacing them in such instances may not be contractually
possible or may be too costly to implement.
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We therefore strongly recommend reform of LIBOR and EURIBOR to a hybrid
system based on a reduced number of tenors and currencies and subject to volume
metrics, the auditing of raw data and greater regulatory oversight. A move to a
benchmark based purely on transactions would represent a significant change and
would require and lengthy and orderly transition period – possibly of the order of 5-10
years.
As a footnote, substituting one equity or fixed income index for another, is also not an
exercise to be undertaken without consideration over the costs and benefits of the
action, along with significant advanced notification to clients of the change in order to
give them enough time to disinvest if this is the preference. Any portfolio transitioning
an equity index would likely incur transactions costs. These would be measured by
the amount of overlap between the indices, the commission cost in various markets,
local market taxes, and bid/ask spread of the underlying securities.
(40) How do you consider that the adoption of new benchmarks could be
ensured? Is this best framed in terms of encouraging or mandating the use of
particular benchmarks?
Alternatives to LIBOR and EURIBOR already exist and include the OIS, GCF Repo
Index, EONIA and SONIA. Generally, the market has moved toward the use of OIS
curves for discounting the present values of future cash flows for derivative contracts.
However, these alternatives also have drawbacks. For example, OIS curves are still
the market’s estimation of the future path of (overnight deposit) rates and therefore
subject to some of the same types of weaknesses as LIBOR fixings as they are a
‘snapshot’ of an OTC market.
BlackRock supports greater diversity in the range of benchmarks used; a one size fits
all rate benchmark may no longer be the optimal solution as different investors and
borrowers have different needs and preferences. Given the volume of legacy
business based on LIBOR and EURIBOR and the implications of a radical move
away from them for the end investor, we would strongly recommend that the first
priority should be on the reform of LIBOR to restore its credibility but that
encouraging the use of alternative benchmarks should form an explicit part of the
reform agenda. We do not believe that the use of certain benchmarks should be
mandated for the reasons listed in our response to Question 30.
(41) How can reforms of the regulation of benchmarks be most easily
implemented?
Reforms of rate benchmarks should permit an orderly transition to avoid unintended
negative impacts on Europe’s pensioners and investors. The implementation of
reforms should therefore reflect the nature of the legacy business as set out to our
response to Question 39. We would stress here that it is important that the industry is
given time to develop the mechanisms and processes to support new requirements
and that such requirements, for example, for additional trade reporting, should
leverage existing infrastructure wherever possible.
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Finally, we note that the various rate benchmarks exhibit some important differences
and are themselves located in a number of different regions. We therefore support
IOSCO’s initiative to define global principles for the setting of benchmarks.
(42) What positive or negative impacts, if any, do you see on small and
medium-sized enterprises of the possible regulation of indices, and how could
any negative impacts be mitigated?
BlackRock has no comment on this question.
(43) Are there other impacts which should be considered? If so please specify
the nature of these impacts and provide evidence.
We refer to our responses to Questions 5, 11, 39 and 40.
(44) In which countries are benchmarks used in your sector produced? From
which countries are data used for the production of benchmarks in your sector
sourced? In which countries are benchmarks used in your sector used?
Index providers are based in countries all over the world. The data used to calculate
equity indices comes from exchanges globally. In contrast, LIBOR for historical
reasons, is centred principally in London and EURIBOR in Frankfurt, commodities
futures indices in the US and bond indices are global and are not tied to any
particular region.
(45) Are there non-EU benchmarks which could serve as substitutes? Are there
non-EU benchmark providers which could produce similar benchmarks?
A number of non-EU benchmarks could serve as partial substitutes, for example the
OIS or the GCF Repo Index as already highlighted.
Although equity index substitutes can be reasonably interchanged, it should be noted
that the underlying stock price data used to calculate both is largely the same as it is
based on market transactions. Most fixed income index providers are global
investment banks and, as such, it is neither meaningful nor accurate to tie them to a
specific geographical location.
(46) Are there international benchmarks which could serve as substitutes for
national benchmarks?
As stated previously, there are index substitutes that can be reasonably
interchanged. However, as an example, a UK equity index cannot serve as a
substitute for an emerging markets index. The underlying investment universes must
match and construction methodology must be similar in order for the equity indices to
be reasonable substitutes.
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