What are Financial Benchmarks?
European Benchmark Regulation defines a Benchmark as "any index by reference to which the amount payable under a financial instrument or a financial contract, or the value of a financial instrument, is determined, or an index that is used to measure the performance of an investment fund with the purpose of tracking the return of such index or of defining the asset allocation of a portfolio or of computing the performance fees;
The International Organization of Securities Commission defines Financial Benchmarks as "prices, estimates, rates, indices or values that are:
a) Made available to users, whether free of charge or for payment;
b) Calculated periodically, entirely or partially by the application of a formula or another method of calculation to, or an assessment of, the value of one or more underlying Interests;
c) Used for reference for purposes that include one or more of the following:
determining the interest payable, or other sums due, under loan agreements or under other financial contracts or instruments;
determining the price at which a financial instrument may be bought or sold or traded or redeemed, or the value of a financial instrument; and/or
measuring the performance of a financial instrument. "
What are some examples of Financial Benchmarks?
Some of the Popular examples of Financial Benchmarks include
Interest Rate benchmarks such as LIBOR (London Interbank Offered Rate), EURIBOR (Euro Interbank Offered Rate), TIBOR (Tokyo Interbank Offered Rate) etc.
FX Benchmarks such as WM/Reuter 4 PM London Closing Spot Rate
Overnight Index Swap Rates such as SONIA (Sterling Overnight Index Average), RONIA (Repurchase Overnight Index Average)
Commodity Benchmarks such as LBMA Gold Price, LBMA Silver Price, ICE Brent Index etc.
How are Financial Benchmarks Used?
Financial Benchmarks are used in a variety of financial deals and as explained by Financial Conduct Authority (FCA) "help set prices, measure performance, or work out amounts payable under financial contracts in a wide range of markets". Simply put financial benchmarks act as reference rates for a variety of financial products from student loans to complex derivatives.
More often critical benchmarks such as LIBOR also act as a reflection of current health of banking system or the state of the underlying market they represent.
How are Financial Benchmark Determined?
Each Financial Benchmark has a unique determination methodology based on the underlying data. Generally, submission rates based on underlying transaction data are collected from panel banks/brokers/financial institutions and aggregated by a designated calculating agent. The calculating agent uses proprietary computation techniques to calculate the final benchmark rate and publishes them at a periodic interval to the market.
For E.g. ICE LIBOR is calculated for five currencies across seven tenors by ICE Benchmark Administration and published every business day at 11:00 AM London time. The underlying data for these rates would be computed as a Trimmed Arithmetic Mean from submissions made by multiple panel banks. For more information about LIBOR computation, please see here.
Who are the Main Stakeholders for Financial Benchmarks?
There are various stakeholders who act in the process of determination, dissemination and consumption of Financial Benchmarks. Key amongst them are:
Benchmark Regulators - Statutory/Government Bodies such as Central Banks which monitor the reliability and robustness of benchmarks. E.g., Bank of England, FCA, US Fed etc.
Benchmark Administrators - Designated organisations which define the overall functioning of the benchmark including contributing panel, time and type of publication, governance, calculation methodology etc. E.g., IBA, EMMI, JBA, CME Group etc.
Calculating Agents - Organisations which are entrusted to collect the transactions data/submission rates from panel banks/financial institutions, calculate the final rate according to methodology and disseminate information at the predetermined time. E.g., Thomson Reuters, ICE, EMMI etc.
Contributors - Banks/Brokers/Financial Institutions that contribute the underlying data for calculation of final benchmark rates. E.g., Banks such as Citibank, JPMorgan, Santander, Lloyds Bank etc.
Users - Individual or organisational consumers of the financial benchmarks
Are Financial Benchmarks Regulated?
The amount of regulation surrounding the financial benchmarks has seen an upward shift as a result of manipulation and rigging allegations of some of the key benchmarks such as LIBOR. Regulators around the globe have initiated stricter and comprehensive norms for the regulation of benchmarks to ensure robust and reliable financial markets. Some of the key regulatory recommendations/regulations surrounding financial benchmarks include:
European Benchmark Regulation
IOSCO Principles for Financial Benchmarks
Wheatley Review of LIBOR
Revised Code of Conduct for Major Benchmarks
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