Wednesday, 10 January 2018

The new rules on financial benchmarks: are consumers adequately protected?

Starting with 1 January 2018 the new Regulation on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds (known as the EU Benchmarks Regulation) that entered into force 30 June 2016 (see our earlier report here) is applicable in Member States. The regulation responded to the serious abuses of the regulatory gap in forming financial benchmarks, the most well known being the manipulation of Libor (London Interbank Offered Rate).

Libor is a benchmark that reflects the rate of interest a bank is willing to lend to another bank. It has a significant consumer dimension given that it influences the formation of the prices of consumer loans. The scandal therefore concerned EU consumer and mortgage loan consumers, the most affected being those with variable rate mortgage loans.

What happened in the Libor scandal? Every day a group of the largest banks submitted their interest rates for 10 different currencies and 15 different lengths of loans to the largest benchmark administrator, Thomson Reuters that would average out the submitted rates (see for more here) and publish the average as Libor. Importantly, the rates submitted were estimates that the banks are willing to lend at, and were not based on actual transactions. Subsequent investigations showed that the traders involved colluded by submitting false rates to benefit their institution and themselves. The scandal triggered heavy fines for the banks and criminal sanctions for the traders involved. Some US  based businesses also sued for damages. As far as I know, consumers so far remained (largely) uncompensated. Given the difficulties in proving the damages sustained (see for more here), consumers are likely to be better off with regulatory redress (like in the case of PPI in the UK) that has not happened yet.

The new rules aim to regulate governance and control over the benchmark formation process by improving the quality of data used by benchmark administrators insisting that benchmarks reflect economic realities, and ensuring that the data submitters are subject to adequate control, especially that they avoid any conflict of interest. In addition to these general requirements aiming to secure the safety and reliability of benchmarks, the new rules specially address consumer protection concerns by using the most common EU consumer protection tool, the provision of information.

Consumer protection rules are laid down in Title IV titled 'Transparency and consumer protection'. The key addition of the section is that firms are required to publish a benchmark statement with information specified in Article 27. The benchmark statement should define the economic reality measured by the benchmark and circumstances under which the measurement may be unreliable; identify the elements that are subject to discretion; provide notice of possible factors that may necessitate changes or the cessation of the benchmark and advise that the change may have impact on the financial contract. In addition to these rules, Article 58 of the EU Benchmark regulation amends the 2008/48/EC Consumer Credit Directive and the 2014/17/EU Mortgage Credit Directive in a way to mandate the provision of information on benchmarks. Consumer credit and mortgage firms will be obliged to inform consumers of the name of the benchmark, the administrator and the potential implications of the benchmark on the consumer. these provisions are applicable from 1 July 2018.

Although the recognition of consumer protection concerns should be applauded in such an important regulatory instrument, my impression is that  the special consumer protection rules, the one section devoted to consumer protection, do little to actually protect consumers. I wonder how consumers will understand the complex financial terminologies of benchmarks and how they will assess the associated risks of uncertainties for example of the circumstances under which measurement of economic realities reflected in benchmarks become unreliable, and what can they do even if they would understand the implications of the use of selected benchmarks. We can therefore only hope that the rest of the regulatory instrument setting out the actual process of benchmark formation will make benchmarks sufficiently safe and stable for everyone, including us, consumers.

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