Recent Amendments to the EU Benchmark Regulation and EMIR

The EU Benchmark Regulation (the “BMR”) has recently been amended by Regulation 2021/168 (the “Regulation”)(here), which entered into force on 13 February 2021. The amendments:

• provide for a statutory replacement rate mechanism for critical benchmarks in certain “tough legacy” arrangements;
• extend the current transitional period for third country benchmarks;
• exempt certain third country spot foreign exchange (“FX”) benchmarks from the scope of the BMR; and
• amend EMIR to clarify the interaction between it and the BMR in certain respects.

The Statutory Replacement Rate Mechanism

Major benchmarks, including LIBOR, are widely used as reference rates in a large variety of contracts and financial instruments. While the cessation of such a benchmark could give rise to legal uncertainty and financial stability risks, the BMR did not provide for a harmonised framework for dealing with the cessation or wind-down of such a benchmark.

The Regulation amends the BMR to include a new Chapter 4a, which provides for a statutory replacement mechanism for a benchmark used in:

• any contract, or any financial instrument as defined in the MiFID Directive 2014/65/EU (“Financial Instrument”), that references a benchmark and is subject to the law of one of the Member States; and/or
• any contract, the parties to which are all established in the EU, that references a benchmark and that is subject to the law of a third country and where that law does not provide for the orderly wind-down of a benchmark.

That mechanism empowers the European Commission after:

• the occurrence of a prescribed trigger event;
• conducting a public consultation;
• taking into account official recommendations made by relevant central banks, certain authoritative alternative reference rate working groups, the competent authority of the administrator of any benchmark to be replaced and ESMA,

to designate a replacement rate (the “Replacement Benchmark”) to replace a:

• benchmark designated as critical under the BMR;
• third country benchmark the cessation or wind-down of which would significantly disrupt the functioning of EU financial markets or pose a systemic risk to the EU’s financial system,

(the “Replaced Benchmark”) in any in scope contract or Financial Instrument that contains either:

• no contractual replacement for the Replaced Benchmark, i.e. no contractual “fall-back provision”; or
• a contractual fall-back provision which is deemed “unsuitable”, within the meaning of BMR as amended by the Regulation, by regulators, for instance, because it could have an adverse impact on financial stability or because it requires a third party consent that is not forthcoming,

which are known as “tough legacy” arrangements.

In the case of a benchmark designated as critical under the BMR, the national competent authority of an EU member state in which the majority of the contributors to that benchmark are based also has the power to designate a Replacement Rate in certain prescribed circumstances.

Transitional Period for Third Country Benchmarks

The BMR allows an EU supervised entity to use a third country benchmark until 31 December 2021. The Regulation extends this transitional period until the 31 December 2023 subject to certain conditions. The Commission may further extend this period until 31 December 2025 in a delegated act to be adopted by 15 June 2023, if it provides evidence that this is necessary in a report to be presented by that time. 

To avoid regulatory arbitrage, the transitional period is disapplied with respect to administrators that relocate from the EU to a third country during that transitional period.

Third Country Spot FX Benchmarks

In order to enable EU companies to continue their business activities while mitigating FX risk, the BMR allowed EU supervised entities to use certain spot FX benchmarks provided by third country administrators to calculate contractual payouts, until the end of the transitional period for third country benchmarks at 31 December 2021.  That transitional period has been extended to end 2023 but that leaves outstanding a concern that many third country spot FX benchmarks cannot achieve equivalence, endorsement or recognition under the BMR as they are not subject to regulation under the laws of the relevant third country. 

To avoid EU supervised entities becoming unable to use those third country spot FX benchmarks after expiry of the extended third country transitional provisions, the Regulation empowers the Commission to exempt them from the scope of the BMR.  Third country spot FX benchmarks are eligible for exemption if they:

• reference a spot exchange rate of a third country currency that is not freely convertible, and
• are to be used on a frequent, systematic and regular basis to hedge against adverse foreign exchange movements.

The Commission must, having undertaken a public consultation to identify the relevant benchmarks by 31 December 2022, adopt a delegated act to create a list of exempted spot FX benchmarks by 15 June 2023, updating that list as appropriate. 

EMIR

The Regulation amends EMIR to clarify that derivative transactions that are:

• not currently subject to clearing or margining requirements under EMIR; and
• amended or novated for the sole purpose of replacing a reference benchmark or introducing fallback provisions in relation to a reference benchmark,

will not become subject to new clearing and/or margining obligations as a result of such amendments.  This addresses significant industry concerns regarding gaps in the coverage of changes made in this regard with effect from 11 February 2021 by Regulation (EU) 2021/23 of the European Parliament and of the Council of 16 December 2020 on a framework for the recovery and resolution of central counterparties.