ESMA has issued a second Q&A on the Benchmarks Regulation (BMR) in less than two months that will be of interest to investment funds. The Q&A published on 5 February 2018 confirms that the BMR does not apply to funds that reference indices in their documentation solely to compare the fund’s performance to the performance of an index. This is not an unexpected interpretation of the BMR provisions, but the clarification is nonetheless welcome in that it gives further comfort to fund managers that BMR does not apply if indices are used by funds only for comparison purposes (for example, in a prospectus or promotional literature). Such funds are therefore spared from having to comply with provisions of BMR applying to users of benchmarks. These provisions would include putting in place “robust written plans” if the relevant benchmark materially changes or ceases to exist and reflecting those plans in contractual relationships with clients.
BMR has been in force since 1 January 2018. While it mainly regulates index providers, BMR has also created certain obligations on funds that use benchmarks for tracking the return of an index, defining the asset allocation of a portfolio, or computing performance fees.
ESMA’s February 2018 Q&A also discussed the use of indices for the purposes of tracking their return and defining the asset allocation of a fund’s portfolio.
ESMA has clarified that, in addition to index tracking funds, structured funds that provide investors with algorithm-based pay-outs linked to an index are also considered to be using an index within the meaning of BMR.
Finally, ESMA’s February 2018 Q&A provides that funds, including actively managed funds, fall within the scope of BMR as users of benchmarks if the composition of a fund’s portfolio is constrained by reference to an index.
ESMA’s clarifications in the previous update to the Q&A published on 14 December 2017 dealing with transitional provisions of the BMR are also relevant to investment funds and can be summarised as follows:
- An EU index provider providing a benchmark prior to 1 July 2016 has until 1 January 2020 to apply for authorisation / registration. It may continue to provide existing and new benchmarks during this period and until the authorisation / registration is refused.
- An EU index provider starting to provide a benchmark between 1 July 2016 and 31 December 2017 may continue to provide benchmarks existing on or before 1 January 2018 until 1 January 2020 and until the authorisation / registration is refused. Benchmarks provided after 1 January 2018 for the first time cannot be used by regulated entities such as investment funds unless the index provider obtains authorisation / registration.
- Benchmarks provided by non-EU index providers used in the EU prior to 1 January 2020 may continue to be used on the basis of transitional provisions pending an equivalence decision in respect of a third country regulatory regime, recognition of a third country administrator or an endorsement of a third country benchmark.
These transitional provisions produced a somewhat counterintuitive result in that EU index providers established on or after 1 July 2016 are unable to provide benchmarks usable by funds unless the index providers get authorised / registered while no such restriction is placed on non-EU index providers established after that date. However, the main take-away for investment funds from the Q&A on transitional provisions is that, unless the benchmark in question is provided by an EU index provider established on or after 1 July 2016, existing and new benchmarks produced by EU and non-EU index providers can be used until at least 1 January 2020.
Contributed by: Sergey Dolomanov
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