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Dear CEO | Release Date: 8th September 2022

To read a shorter summary of this Dear CEO letter, click here.

To access the original FCA document, click here.

Long Summary

The Financial Conduct Authority (FCA) is responsible for ensuring that financial markets in the UK operate effectively and fairly. In alignment with this objective, the FCA closely monitors and regulates the activities of benchmark administrators due to their significant impact on the overall financial system. This detailed summary elaborates on the expectations and strategic approach outlined by the FCA for benchmark administrators, highlighting compliance requirements, potential risks, and operational standards essential for maintaining market integrity.

The Role and Importance of Benchmark Administrators in Financial Markets

Benchmark administrators play a crucial role by providing precise and reliable benchmarks essential for pricing assets, managing risks, and executing financial strategies. These benchmarks influence countless financial instruments and transactions globally, affecting outcomes for various financial products, firms, and entire markets. As such, the integrity and accuracy of the benchmarks provided are of paramount importance.

Regulatory Framework and Compliance

Benchmark administrators operate under the rigorous framework of the UK Benchmark Regulations (UK BMR). These regulations are supplemented by the FCA’s Principles and Rules, which include the Senior Managers Regime and Conduct Rules. The Senior Managers Regime is particularly critical as it ensures that senior figures within organisations are accountable for compliance and the integrity of the benchmarks they administer.

Integration with Consumer Duty

Though the direct activities of benchmark administrators fall outside the immediate scope of the new Consumer Duty, their work significantly impacts other firms within the product distribution chain that are subject to this duty. As a result, the FCA expects administrators to facilitate these firms in fulfilling their obligations under the Consumer Duty by providing necessary data and ensuring transparency.

Supervisory Priorities for Benchmark Administrators

The FCA has delineated specific supervisory priorities based on an extensive review of compliance risk areas among benchmark administrators. These priorities aim to address the most significant risks and ensure administrators uphold the standards required by regulators.

Disclosure Practices

Risk Overview:

Inadequate disclosure by benchmark administrators can lead to significant misunderstandings about how benchmarks are calculated and their suitability for certain applications. This is particularly problematic for complex or specialised benchmarks such as those used in ESG investing or credit-sensitive rates.

Expectations for Improvement:

Administrators are expected to enhance the clarity, completeness, and transparency of their benchmark disclosures. This includes providing comprehensive benchmark statements that clearly explain the methodologies, data sources, and economic realities the benchmarks intend to measure.

Quality of Data and Controls

Risk Considerations:

The quality and integrity of data used in benchmark calculations are crucial. Issues such as data inaccuracy, inadequate validation processes, or reliance on flawed third-party data can undermine the reliability of benchmarks.

Regulatory Expectations:

The FCA expects benchmark administrators to establish robust systems for data verification and methodology implementation. They should actively manage data quality, including promptly addressing any identified issues or inaccuracies.

Operational Resilience

Risk Implications:

Operational disruptions pose significant risks, potentially leading to inaccuracies in benchmark calculation or delays in their dissemination.

Operational Standards Required:

Administrators must ensure they have comprehensive plans and systems in place to maintain operations during disruptions, including effective business continuity and disaster recovery strategies.

Governance and Oversight

Challenges in Governance:

Effective governance is crucial for maintaining compliance and managing conflicts of interest. Poor governance can lead to oversight failures and compromised benchmark integrity.

Governance Enhancements:

The FCA mandates that administrators strengthen their governance frameworks, ensuring clear accountability and rigorous oversight mechanisms are in place. This includes managing conflicts of interest effectively and maintaining detailed records of decision-making processes.

Specific Focus Areas

ESG Benchmarks

Given the surge in passive investments linked to sustainability, the accuracy and transparency of ESG benchmarks are under intense scrutiny. Administrators must ensure these benchmarks accurately reflect their stated sustainability criteria and market expectations.

Credit Sensitive Rates (CSRs)

With the phase-out of LIBOR, the focus on CSRs has intensified. The FCA is vigilant about the potential risks associated with these benchmarks, emphasising the need for administrators to manage them prudently to avoid replicating past issues seen with LIBOR.

Compliance and Strategic Actions

Benchmark administrators are urged to regularly review and update their disclosure practices, data quality controls, operational resilience plans, and governance structures to meet the heightened expectations set by the FCA. This involves a proactive approach to compliance and engagement with regulatory developments.

Conclusion and Next Steps

The FCA expects benchmark administrators to thoroughly assess and address the issues highlighted in the guidance. Administrators should be prepared for ongoing evaluations and maintain open, proactive communications with the FCA, especially regarding significant operational changes or updates to benchmark methodologies.

Administrators must ensure they are fully compliant with all regulatory requirements and are expected to engage constructively with the FCA to promote transparency, fairness, and efficiency in financial markets.

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