In June 2019, the RBI issued guidelines for Financial Benchmark Administrators (FBAs), which control ‘significant benchmarks’ in the markets for financial instruments regulated by the banking regulator.
As per the RBI notification, the role of FBAs is to control the creation, operation and administration ‘benchmarks’ like prices, rates, indices, values or a combination thereof related to financial instruments that are calculated periodically and used as a reference for pricing or valuation of financial instruments and contract.
Before going into the details of Financial Benchmark Administrators, we should understand financial benchmark, the art of financial benchmarking and some of the global developments that led to the creation of Financial Benchmark Administrators in several countries.
What is a financial benchmark?
Financial benchmarks are standard rates primarily used for pricing, valuation and settlement purposes in financial markets and contracts.
At their core, financial benchmarks are rates (interest rate) or prices (of bonds) that are referenced or used in a variety of financial contracts to determine a value or payment.
For example, a firm may borrow money today and pay the lender interest based on the market interest rates, indicated in a financial benchmark.
Financial rates like the standard interest rate, exchange rate, government security’s yield etc are some of the important benchmarks in the financial system.
In the stock market, bulk of the deals are in derivatives which are an important type of financial product that uses financial benchmarks (index changes) for settling the payment.
So, significance of such rates is that, it is based on these rates that trading on various financial contracts like derivatives are settled. Hence, a reliable and precise benchmark interest rate (like the MIBID, MIBOR), exchange rate for rupee etc., are very essential.
These standard rates or benchmarks are set after analysing the current market data about the relevant financial transactions. Hence, there is significant level of sophisticated data analysis without any fault that is included under setting financial benchmark setting like determination of the market exchange rate for rupee and the US Dollar.
Importance of Financial Benchmark Administrator
The institutions that have the authority to find and set such benchmarks are called Benchmark Administrators.
A major criterion is that besides the sophisticated collection of data, analysis etc, the benchmark administrator should not have shown any fault like bias, manipulation etc. He should not have conflict of interest. Here, if he/entity is in some other position like that of a regulator or the owner of a financial market entity, he may manipulate the data. Here comes the vital importance of a capable financial benchmark administrator.
The LIBOR scandal and the current wave of reforms in financial benchmarking
The area of financial benchmarking became important since the LIBOR scandal of 2012 where some banks rigged or manipulated financial benchmark of LIBOR to make gains. Severe punishments were given to such banks and after this lesson, regulators across the globe including the RBI are in a process to fortify financial benchmarking process.
“Public authorities and the financial industry are now collaborating globally to improve the reliability, resilience and governance of financial benchmarks to restore the confidence of both markets and the public in these rates.” – (Reforming Financial Benchmarks: An International Perspective; Bank of Canada).
Financial Benchmark Reforms in India – LIBOR lessons, Vijay Bhaskar Committee and the setting up of FBIL
After the shocking LIBOR scandal, benchmark reforms were attempted in India as well. A committee under Vijay Bhaskar made recommendations to the RBI on financial benchmarking reforms in the country.
The financial benchmarks or important rates in India were determined by two benchmark administrators – FIMMDA and FEDAI. The Fixed Income Money Market and Derivatives Association of India (FIMMDA) and Foreign Exchange Dealers’ Association of India (FEDAI) administered interest rate benchmarks (like MIBOR and MIBID) and FEDAI administered exchange rate of rupee respectively.
But as a follow up of the report and trends in global reform developments, the RBI instructed the creation of a new entity as a financial benchmark administrator with the joint coordination of the existing players.
Conflict of interest and the setting up of FIBIL
According to the RBI, the FIMMDA and FEDAI must govern benchmarking system. If they continue to estimate the rates, there can come conflict of interests. The International Organisation of Securities Commissions (IOSCO) -the international body for setting benchmark regulation reforms advocated that conflict of interest is a big risk in benchmark setting.
“In order to overcome the possible conflicts of interest in the benchmark setting process arising out of the current governance structure of the FIMMDA and FEDAI, an independent body, either separately or jointly, may be formed by the FIMMDA and FEDAI for administration of the benchmarks,”. The RBI circular issued on April 16th, 2014 indicates.
After this RBI regulation, the FIMMDA, FEDAI and IBA (Indian Bank Association) jointly formed the Financial Benchmark of India Limited (FBIL).
Financial Benchmark India Pvt. Ltd (FBIL)
FBIL is an entity jointly created by the financial benchmark administrators – FIMMDA and FEDAI and the IBA to administer financial benchmarks. It is owned by three organizations: FIMMDA (76%) FEDAI (14%) and IBA (10%).
The FBIL was formed in December 2014 as a private limited company under the Companies Act 2013. FBIL is regulated by Reserve Bank of India, for administering specific benchmarks. Its objective is to develop and administer India’s benchmarks relating to:
- Money Market,
- Government Securities and
- Foreign Exchange Market
RBI’s new guidelines for creating Financial Benchmark Administrators (FBAs) on significant benchmarks
The new guideline issued by the RBI is a move to create dedicated FBAs on significant financial benchmarks. Though the FBIL is administering benchmarks, fresh entities may add sophistication to financial benchmarking in the country. In recent years, financial benchmarking across the world have gone beyond the level of India’s existing standards. This may have prompted the RBI to make additional steps.
Who is a Financial Benchmark Administrator?
According to the RBI, “Financial Benchmark Administrator (FBA) means a person who controls the creation, operation and administration of financial benchmark(s).”
FBAs should have the control the creation, operation and administration ‘benchmarks’ like prices, rates, indices, values or a combination thereof related to financial instruments that are calculated periodically and used as a reference for pricing or valuation of financial instruments or any other financial contract.
By administration, RBI implies includes all stages and processes involved in the production and dissemination of a benchmark.
RBI issued guidelines for setting up of financial benchmark administrator (FBA) for administering “significant benchmarks” in the markets for financial instruments.
Following are the minimum eligibility criteria for FBAs:
- FBA shall maintain a minimum net-worth of Rs 1 crore at all times.
- FBA shall be a company incorporated in India.
- Shareholding by non-residents, should be in accordance with the set regulations including the FEMA Act
- FBA shall have robust governance arrangements and organisational structure to manage the activities of FBA. Directors shall be of good repute and experience.
- The representation in the Board of the company shall be broad-based; no legal person should own greater than ten percent of voting rights in the Board.
Responsibilities of FBAs
The FBAs shall be responsible for:
a. formulation of benchmark calculation methodology;
b. determination of benchmark values;
c. dissemination of benchmark values;
d. ensuring transparency in benchmark administration;
e. periodic review of benchmark; and
f. putting in place necessary organizational and process controls for effectively carrying out the above responsibilities.
- The existing FBAs shall achieve the minimum eligibility requirements within one year from the date of authorisation by the Reserve Bank.
The existing FBA is the FBIL and hence these regulations are applicable for FBIL as well.
Revocation of authorisation
The Reserve Bank may revoke the authorisation granted to an FBA based on adverse findings/ observations or material violation of any of the provisions of these directions.
What are significant benchmarks?
In a later notification, the RBI identified various significant benchmarks. There, the following benchmarks presently administered by the FBIL are identified by the RBI as significant benchmarks.
(1) Overnight Mumbai Interbank Outright Rate (MIBOR)
(2) Mumbai Interbank Forward Outright Rate (MIFOR)
(3) USD/INR Reference Rate
(4) Treasury Bill Rates
(5) Valuation of Government Securities
(6) Valuation of State Development Loans (SDL)