Introduction

1. Data is essential to wholesale markets to enable them to function effectively. Data used to settle financial contracts must be reliable, robust and free from manipulation or interference. Since the introduction of the Benchmark Regulation (the BMR), the FCA have been responsible for the supervision of benchmark administrators. The FCA estimate aggregate revenues from indices data and the licensing of benchmarks to UK-domiciled customers to be around £600m in 2022. In the last year, the FCA have published documents which shed light on the regulator’s focus in relation to benchmarks. These include the Whole Data Market Study Update Report published in August 2023 and the Dear CEO letter to Benchmark Administrators in September 2022. This article looks at some of the themes emerging from these documents, and draws on the author’s practical experience of advising benchmark administrators. It will be of interest in particular to benchmark administrators, but also to anyone involved in wholesale markets.

Background

2. Indices provide information about a wide range of markets. In the UK BMR, an index is defined as a figure that is publicly available and is regularly determined, either by applying a formula or other calculation, or by making an assessment based on the value of one or more underlying assets/prices (including estimated prices, actual or estimated interest rates, quotes and committed quotes, or other values or surveys). In wholesale markets, indices are widely used to benchmark performance or determine the price of financial products. Indices are generally classified by the asset class of the underlying assets: equity, fixed income, commodity, interest rate, foreign exchange, cryptocurrencies, others (e.g. multiple asset classes, ESG).  Public indices fall within the ambit of the BMR when they are used to determine the amount payable under a financial contract or measure the performance of an investment fund.

How many UK Benchmark Administrators are there?  

3. Benchmark administration businesses tend to operate internationally, not just within the UK. The UK BMR governs the supply and use of benchmarks within the UK. There is a separate, but effectively identical, regime for the supply and use of benchmarks within the EU, and certain other countries also have benchmarks legislation. In the UK, the BMR is subject to a transitional provision until the end of 2025 allowing non-UK benchmark administrators to license benchmarks in the UK without making an application to the FCA until the end of this period. There is a similar transitional provision in place in the EU under the EU BMR.

4. The FCA maintains a Benchmarks Register which lists (i) benchmark administrators within the UK, and (ii) benchmark administrators from outside of the UK who have received FCA approval under the third country provisions of the BMR (third country administrators). As of November 2023, the register lists 36 UK benchmarks administrators and 10 third country administrators. The register does not list administrators based outside of the UK relying on the transitional provision to supply benchmarks to the UK.

Commercial Models

5. Most benchmark administrators rely on licence fees from clients for the supply of index data and its use as a benchmark. Licences vary across providers, because of the different asset classes and ways that indices are used. However, the FCA summarise the main licence products as follows:

• subscriptions to receive index data as it is updated and some level of additional ancillary data, such as data on the index constituents, for uses outside the scope of the BMR;

• subscriptions to use indices as benchmarks for a determined contract length where the fees are based on factors such as number of individual users at the clients’ site or number of access locations;

• subscriptions for use in index-linked financial products where fees are determined based on the value or volume of trading in those financial products; and

• redistribution licences for use of an index for the creation of another index.

6. The FCA also note variation across administrators in packaging of multiple indices: some providers allow clients to select individual indices they require, others license index families or offer blanket subscriptions to all their indices. Providers may also charge a supplemental fee to allow access to their data through a market data vendor. Many benchmark administrators have additional business lines. Several are part of groups that operate in multiple areas in the financial sector. For example, generating other market data (eg credit ratings), distributing market data, exchanges and trading venues, asset management, research and analytics and brokerage services. The FCA estimates that a large proportion of the benchmark administration market is taken up by three main providers: FTSE Russell, MSCI and S&P.

Use

7. According to the FCA, most benchmark users are financial firms, such as asset managers, banks, wholesale brokers, PTFs, and trading venues. The remaining users are non-financial firms, such as data and analytics firms, technology providers, and education organisations. For certain types of benchmarks there are more niche end users, for example some commodities benchmarks are used by utility firms and manufacturing firms. Users receive the data either directly from the benchmark provider, or indirectly through market data vendors. Demand for benchmarks has increased in recent years, due to a number of factors, including (a) increased use of passive rather than active funds, (b) demand for ESG benchmarks, (c) demand for specialised or bespoke indices.

Competition

8. The FCA’s Market Study and the focus on benchmarks is part of a wider examination of competition in the wholesale data markets. The market study has been made using the FCA’s competition powers under the Enterprise Act 2002. The market study is intended to enable the FCA to develop an in-depth understanding of whether a market is working well and, if not, why. The publication in August was an interim report, with a final report expected in March 2024. In the interim report, the FCA has elected not to make a reference to the Competition & Markets Authority. However, the FCA has expressed concerns about market features, such as lack of transparent pricing practices, excessive charging, bundling practices and complex licensing agreements. If the FCA confirm suspected competition problems in one or more markets, it has the opportunity to make representations to the Treasury to amend existing powers, or grant the FCA new ones, where this is needed.

9. The FCA’s potential concerns, identified at this interim stage, are summarised at (a) to (j) below:

• Concentration – benchmark markets are concentrated, with some benchmarks considered a ‘must-have’ for users. Concentration is not inherently harmful, but it can lead to less incentive to compete on price, quality and innovation.

• Network effects – the more widespread a benchmark, the more valuable it is to users. These network effects can lead to concentration, and make changing the benchmark more difficult. As above, this is not inherently harmful unless it impedes competition.

• Brand awareness – a respected, well-known and trusted brand can risk reducing competition if users refuse to change.

• Barriers to entry – input costs and start up costs can be high, preventing new entrants into the market.

• Vertical integration – some benchmark administrators are part of a vertical group, meaning that they operate at multiple levels of the value chain (e.g. providing input data, producing benchmarks, using benchmarks). Again, this is not inherently anti-competitive but can lead to persistent market power.

• Licensing terms – some respondents to the FCA survey expressed concerns about benchmark administrators licensing terms being complex and non-transparent (e.g. fee schedules not being published).

• Bundling – users have flagged to the FCA that they sometimes have to buy products as part of a wider package that they do not use.

• Termination costs – users have suggested that certain costs imposed by benchmark administrators on users at termination, such as removing all historical data from their systems, may be unreasonable.

• Quality & risk – many benchmark administrators’ terms include exclusions or limitations of liability. The lack of an alternative leaves users in a weak bargaining position, forced to accept these terms.

• Impact on investors – if users pay higher prices for data, then that is likely to harm investors.

10. The next steps in relation to the market study will be the publication of the FCA’s final report in March 2024. Given the lengthy list of possible competition concerns set out above, it will be surprising if the FCA do not make some recommendations to the Treasury about possible areas for reform.

Disclosure

11. In its Dear CEO letter of September 2022, the FCA emphasized the importance of disclosure, to allow users to assess how a benchmark is calculated. The key documents for doing this are the benchmark statements and the methodology. It is important that benchmark administrators review these documents regularly, and ensure that they properly describe the economics that they are measuring. The FCA expect administrators not to group families of benchmarks at too high a level. The FCA expressed particular concern about ESG benchmarks and credit sensitive rates (CSRs). For ESG benchmarks, the methodologies and statements must be clear about exactly what is being measured, and how sustainability is assessed. Where an administrator intends to publish a CSR, it must inform the FCA in advance.

Quality of Data and Data Controls

12. Noting the importance of input data, the FCA remarked that benchmark administrators are increasingly relying on third parties to provide such data. These third parties may be unregulated and / or based overseas, and have poor data quality and controls. The FCA have observed calculation errors and poor validation of data inputs. The FCA expect administrators to have robust procedures to monitor, check and challenge inputs from third parties. This means that, where an error occurs, and a notification is made to the FCA, the regulator may well ask to see the benchmark administrators’ policies and procedures. Failure to have appropriate procedures could result in an investigation of the administrator. The FCA also emphasizes the importance of notifying it regarding errors, and the use of “lessons learned” exercises to make improvements.

Cryptoasset Benchmarks

13. The FCA expect a benchmark administrator which intends to start administering a cryptoasset benchmark to notify it in advance.

Operational Resilience

14. The FCA expect all benchmark administrators to be operationally resilient. This means having an effective control framework to monitor compliance with the BMR. This also means managing operational risk, having business continuity procedures and disaster recovery plans, and contingency procedures in the event of disruption to the benchmark. Where the administrator has outsourced functions, the administrator will continue to be responsible for discharging the administrator’s responsibilities under the BMR. Any outages (for example as a result of technological failures or cyber attacks) must be notified to the FCA. Where third parties repeatedly breach service levels, the FCA expects firms to take action, up to and including ending the relationship with the third party.

Oversight and Governance

15. The FCA expects firms to identify and manage conflicts of interest. The administrator must maintain a permanent oversight function to oversee governance arrangements, and decisions must not be influenced by specific user groups. Any changes to policies and procedures should have clearly documented rationales and audit trails. Now that the Senior Managers Regime (SMR) applies to benchmark administrators, the FCA expect them to be adhering to the relevant SMR requirements, including assessing senior manager’s fitness and propriety on an annual basis and reporting conduct breaches.

Conclusion

16. The introduction of the BMR brought hitherto unregulated data businesses within the regulatory perimeter. Reading between the lines of the communications which the FCA has issued, there is still work to be done to bring benchmark administrators up to the standards expected of regulated firms. Firms should review their governance, disclosures (such as benchmark statements and methodology), data controls and terms of business. The FCA have limited time to conduct thematic audits of these areas, so a spotlight tends to be shone on firms when something goes wrong. This might be the discovery of persistent errors by a third party calculation agent, or an outage, or other issue. Once this has been notified to the FCA (or otherwise comes to its attention), the regulator will ask probing questions of the benchmark administrator, and ask it to provide evidence of its systems, controls, policies and procedures. If these are materially deficient, then the FCA may exercise its enforcement powers.

17. Furthermore, the FCA seem to have some concerns about competition, particularly among the major equity indices. The consolidation within the industry in recent years (see e.g. LESG / Refinitiv, S&P / IHS Markit) has increased the power held by certain administrators. It will be interesting to see what recommendations are made when the final report is published in March next year, although the fact that the competition issue has not been referred to the CMA may provide some comfort to administrators.