FinTech in Turkey: Overview
Ekin İnal and Ecem Naz Boyacıoğlu provide an overview of FinTech in Turkey.
This year the buy-side regulatory headlines have been dominated by the EU’s Markets in Financial Instruments Directive II (MiFID II), Brexit and the Financial Conduct Authority’s (FCA) asset management market study. As 2018 approaches, there is another significant regulatory development on the horizon that asset managers would be ill advised to ignore. This is the EU Benchmarks Regulation.
In 2012, as a result of scandals, the then CEO of the FCA, Martin Wheatley, was asked to conduct a review into the London Interbank Offered Rate (Libor). The resulting report, the ‘Wheatley Review’, recommended criminal sanctions for benchmark manipulation, and a program of reform, rather than replacement, for Libor (including its transfer to a new administrator, improvements in the methodology for calculating the benchmark, and that administration of and submission to Libor be made regulated activities under the Financial Services and Markets Act 2000).
Libor’s administrator and its 20 panel banks became regulated for benchmark activities on 1 April 2013. In April 2015 the list of regulated benchmarks in the UK was enlarged to include seven other major benchmarks – LBMA Gold Price, and LBMA Silver Price, the ICE Swap Rate, SONIA, RONIA, the WM/Reuters London 4pm Closing Spot Rate and the ICE Brent Index.
The administrators of these benchmarks are subject to FCA rules that require them to put in place appropriate governance arrangements (including the formation of an oversight committee) to have effective controls to ensure the integrity of input data and to keep adequate records. Benchmark submitters are subject to similar requirements to ensure that they manage any conflicts of interest and are subject to an annual audit. Both administrators and submitters need to have a named individual responsible for compliance with these rules.
While work was being undertaken in the UK, the International Organisation of Securities Commissions (IOSCO) developed global Principles for Financial Benchmarks, published in July 2013. These principles created a common cross-jurisdictional framework for good market practice and have been widely adopted as industry standards. They impress upon administrators the need for strong governance, robust benchmark design, transparent methodologies and clear accountability.
On 29 June 2016, Regulation (EU) 2016/1011 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds (the Benchmarks Regulation) was published in the Official Journal of the EU. It entered into force on 30 June 2016. The Benchmarks Regulation generally applies from 1 January 2018 subject to certain transitional provisions (see below). The Benchmarks Regulation, being directly applicable in Member States, will supersede the UK’s existing requirements.
Article 3(3) of the Benchmarks Regulation sets out the definition of “benchmark”. The definition does not hinge on what the benchmark references, but how it is used:
“’benchmark’ means any index by reference to which the amount payable under a financial instrument or a financial contract, or the value of a financial instrument, is determined, or an index that is used to measure the performance of an investment fund with the purpose of tracking the return of such index or of defining the asset allocation of a portfolio or of computing the performance fees.”
Article 3(1) of the Benchmarks Regulation defines an “index” as meaning any figure
A Commission Delegated Regulation sets out further guidance as to the meaning of “published or made available to the public” (Commission Delegated Regulation of 29 September 2017 supplementing Regulation (EU) 2016/1011 of the European Parliament and of the Council specifying technical elements of the definitions laid down in paragraph 1 of Article 3 of the Regulation).
Article 2 of the Benchmarks Regulation sets out certain exemptions to the definition of benchmark. Benchmarks provided by central banks or other authorities for public policy purposes are excluded. Also, benchmarks that reference a price of a single financial instrument (such as the price of a specific share) are not in scope1. Standard variable rates offered by credit institutions will not be considered benchmarks when used in mortgage or consumer credit contracts.
Applying the principle of proportionality, the Benchmarks Regulation classifies benchmarks as ‘critical’, ‘significant’ and ‘non-significant’, and the nature and degree of the requirements under it will be determined by these classifications. A benchmark is deemed to be either ‘critical’ or ‘significant’ where it satisfies the conditions set out in Articles 20(1) or 24(1) of the Benchmarks Regulation2. A ‘non-significant’ benchmark is one that meets the definition of ‘benchmark’ but does not satisfy the conditions to be either a critical or significant benchmark (Article 3(27) of the Benchmarks Regulation)3. The Benchmarks Regulation also contains requirements for different types of benchmark: regulated-data benchmarks (Article 17), interest rate benchmarks (Article 18) and commodity benchmarks (Article 19).
The primary impact of the Benchmarks Regulation will be on benchmark administrators, as it introduces a requirement for their prior-authorisation/registration (Article 34) and ongoing supervision (Articles 4 to 14 and 27 to 28). Where an administrator has been authorised its details shall be placed on a public register maintained by the European Securities and Markets Authority (ESMA) (Article 36 of the Benchmarks Regulation). ESMA will start publishing this register as from 1 January 2018. The ongoing requirements, like the IOSCO Principles, cover governance and accountability as well as the design and methodology of any benchmarks provided.
The Benchmarks Regulation also introduces a code of conduct for contributors of input data requiring the use of robust methodologies and sufficient and reliable data (Article 15 of the Benchmarks Regulation). It also sets out governance and control requirements for contributors (Article 16 of the Benchmarks Regulation).
The Benchmark Regulation also impacts users of benchmarks who are already 'supervised entities' (defined in Article 3(17) of the Benchmarks Regulation). This includes alternative investment fund managers (AIFMs), undertakings for collective investment in transferable securities (UCITS) management companies (and self-managed UCITS), MiFID II investment firms and credit institutions as defined by the Capital Requirements Regulation.
Supervised entities will need to consider carefully whether they ‘use’ a benchmark. Article 3(7) of the Benchmarks Regulation defines ‘use of a benchmark’ as:
Asset managers represent an important group of benchmark users, either in the case of passive managed funds and exchanged traded funds – where benchmarks are used as a target for index linked funds – or in the case of the evaluation of an active manager’s performance – where the fund performance is measured against a selected index or a set of indices. Asset managers as benchmark users are generally not involved in the production, calculation and contribution to data on which benchmarks are based4.
Where a fund uses a benchmark to measure its performance for the purpose of either tracking the return of the benchmark or defining the asset allocation of the portfolio or computing performance fees payable by it, such use will fall within the scope of the Benchmarks Regulation (Article 3(7)(e) of the Benchmarks Regulation)5.
Also, a fund will be considered to use a benchmark where it enters into a derivative contract (the underlying of which is a benchmark) which is traded on a trading venue unless the terms of that contract are set by:
The Benchmarks Regulation provides that:
The Benchmarks Regulation provides for the following mechanisms under which third country benchmarks may be used by supervised entities in the EU
In each of the above cases, the details of the third country administrators shall be placed on the public register maintained by ESMA.
Article 51 of the Benchmarks Regulation provides for certain transitional periods
Article 52 of the Benchmarks Regulation provides that for UCITS prospectuses approved prior to 1 January 2018, the underlying documents shall be updated on the first occasion or at the latest within 12 months after that date.
For some firms the introduction of the Benchmarks Regulation will not come as a huge shock where they have already been raising their standards under the IOSCO Principles. However, for other firms meeting the new requirements will be a challenging exercise.
Any supervised entity, including AIFMs and UCITS managers, should carefully consider their risk exposure to the Benchmarks Regulation. They should create an inventory of the benchmarks that they use, and seek assurances from the administrators of those benchmarks that they are aware of the Benchmarks Regulation and have plans in place to comply with it from 1 January 2018. This is particularly important where the benchmarks are provided by smaller administrators, particularly in third countries. Supervised entities should also be thinking about potential alternative benchmarks in case any benchmark they currently use becomes unavailable, and the creation of written contingency plans mentioned above. For UCITS funds, new prospectuses will need wording regarding compliance with the Benchmarks Regulation as will existing prospectuses that are updated.
Further information can be found in Q4.2 of ESMA Questions and Answers on the Benchmarks Regulation.
On critical benchmarks see also Articles 21 to 23 (inclusive) of the Benchmarks Regulation. For significant benchmarks see also Article 25.
For the requirements concerning non-significant benchmarks see Article 26 of the Benchmarks Regulation.
See EFAMA response to the ESMA Discussion Paper on Benchmarks Regulation Public Comment.
See also recital 13 of the Benchmarks Regulation: Financial benchmarks are not only used in the issuance and manufacturing of financial instruments and contracts. The financial industry also relies on benchmarks for measuring the performance of investment funds for the purpose of return tracking or of determining the asset allocation of a portfolio or of computing the performance fees. A given benchmark can be used either directly as a reference for financial instruments and financial contacts or to measure the performance of investment funds, or indirectly within a combination of benchmarks. In the latter case, the setting and review of the weights to be assigned to various indices within a combination for the purpose of determining the pay-out or the value of a financial instrument or a financial contract or measuring the performance of an investment fund also amounts to use as such an activity does not involve discretion, in contrast to the activity of provision of benchmarks. The holding of financial instruments referencing a certain benchmark is not considered to be use of the benchmark.
See Q5.2 of ESMA Questions and Answers on the Benchmarks Regulation.
Ekin İnal and Ecem Naz Boyacıoğlu provide an overview of FinTech in Turkey.
During his State of the Nation Address, the President gave reassuring impetus to solving the current energy crisis and perennial load shedding that has been decimating the economy.