A key purpose of the financial system is to allocate capital and risk in a manner that supports sustainable economic development and growth, including through the provision of financing, investment and hedging products. Financial benchmarks/indices are fundamental to the functioning of financial markets and are widely used in both retail and wholesale markets. In particular, benchmarks are a valuable tool helping market participants to set prices, measure performances, or work out amounts payable under financial contracts or instruments.
Benchmarks increase market transparency, facilitate diversification and risk management, simplify performance measurement, and support decision-making. By developing innovative benchmark products, benchmark administrators foster investments in areas that are economically, socially, and environmentally beneficial.
Historically, financial benchmarks were not regulated. Following significant misconduct resulting in benchmark failings (especially after the financial crises in 2008-2010 and for FX benchmarks), confidence in benchmarks and participation in the related financial markets were threatened. Misconduct and manipulation cases affected market stability and prompted FCA interventions in the UK (e.g. in 2014 the fines for such manipulation added up to £1.1bn).
As part of a wider effort to restore market confidence, regulators around the world began to implement regulation of financial benchmarks. As part of these regulatory efforts and as a starting point, IOSCO published principles on financial benchmarks in 2013. The IOSCO principles address conflicts of interest in the Benchmark-setting process, as well as transparency and openness when considering issues related to transition.
The implementation of a regulatory framework for financial benchmarks coincides with an increasingly digital global financial market. Given that asset management is already a largely digitised industry, digital technologies have the potential to bring about massive innovation in the financial industry in the coming years. Asset management will be significantly influenced by better availability of data, algorithms, digitization of assets, new processes for custody and settlement as well as reporting. Good financial benchmark data is a prerequisite for the provision of any service along the entire value chain in asset management and banking, from research, trading, portfolio and risk management to clearing and settlement.
Financial benchmark data is often provided by natural monopolies and oligopolies such as stock exchanges or rating agencies and companies with a dominant market position such as large benchmark providers or data vendors. These companies have significant market power and can unilaterally set virtually all contractual conditions since the customers on the asset management or banking side cannot undertake the activities that are essential to their business without the data provided by these firms. The use of financial benchmark data has therefore been subject to regular, sometimes massive, price increases and the imposition of increasingly complex and arguably overpriced data licenses, which effectively cover all types of use along the whole value chain of the financial services industry.
This paper identifies material challenges arising from continually increasing financial benchmark data costs to the effective functioning of markets, and proposes initiatives to address this problem. Such initiatives are consistent with their regulatory purpose of promoting sound financial market regulation.
Given the importance of the consequences to the general wellbeing of financial markets related to the provision of Benchmark data, we recommend that governments, regulators, central banks, and standard setters establish core principles to address the problem.
As a starting point, regulators should recognize that certain benchmark administrators hold disproportionate market power on financial benchmark data. A healthy competition which leads to an increase in the number of challenges and the diversity of benchmark markets does not properly exist. On the contrary, in recent years some long-established “benchmark administrators” sold their index businesses to well-positioned operators committed to investing and growing their firms. As such, financial benchmark data costs must be subject to regulatory oversight. Rigorous supervision of the entire financial benchmark data business (as well as contiguous markets and products where the search for revenue could shift once there is increased scrutiny of financial benchmark data sales) is crucial to maximize the economic benefits of financial markets.
This paper aims at taking a holistic approach and horizontal view on data costs at the EU level. Therefore, we apply the same considerations in terms of costs that we have for benchmark providers more broadly to all market data providers, including rating agencies.